Preproductive Period in Farming: Capitalization Rules and Elections

The preproductive period in farming is the stretch between planting a crop or acquiring an animal and the moment that asset starts producing something you can sell. It matters because federal tax law generally will not let you deduct the costs you incur during that window if it runs longer than two years. Those costs get capitalized into the asset’s basis under Section 263A, the Uniform Capitalization (UNICAP) rules, and you recover them later through depreciation or at sale rather than on this year’s return.¹

When the Period Starts and Ends

For plants that will produce more than one harvest, the period runs from the day you put the seed or seedling in the ground until the plant yields its first marketable crop. For plants you intend to sell outright rather than harvest repeatedly, the period runs until you reasonably expect to dispose of the plant. Using a plant’s output in your own farming operation counts as a disposition, so the period can end even if you never sell to an outside buyer.¹

For animals, the clock starts when you acquire or breed the animal and ends when it becomes productive for its intended purpose. A dairy heifer’s period closes when she has her first calf and enters the milking herd. A steer raised for beef finishes when it reaches the target weight or age for slaughter.

You do not get to set a convenient endpoint. The IRS uses the nationwide weighted average preproductive period for each commercially grown plant to decide which side of the two-year line a crop falls on, and that line controls whether the rules apply to you.

The Two-Year Test

If a plant’s nationwide weighted average preproductive period is two years or less, UNICAP generally does not apply. Corn, soybeans, wheat, cotton, and vegetables planted and harvested within a single growing season all sit comfortably below the line, which is why most U.S. farming operations never confront these rules.

The IRS publishes the list of plants that exceed two years. It includes almonds, apples, apricots, avocados, blueberries, cherries, coffee beans, dates, figs, grapes, kiwifruit, lemons, limes, macadamia nuts, mangoes, nectarines, olives, oranges, peaches, pears, pecans, pistachio nuts, plums, pomegranates, walnuts, and a range of other tree fruits and nut crops.² Grow anything on that list and UNICAP applies unless an exemption or election gets you out.

The same two-year cutoff governs animals. Poultry and hogs generally reach productive status well within two years. Dairy and beef cattle often cross the line, particularly replacement heifers that are not bred until roughly 15 months and do not calve until about 24 months. Horses almost always exceed two years.

Costs You Have to Capitalize

When your crop or animal falls on the wrong side of the line, both direct and indirect growing-phase costs get added to the asset’s basis instead of deducted.

Direct costs are the ones tied straight to growing the asset: feed for young livestock, seed and fertilizer for a new orchard, wages paid to workers who plant, prune, or care for immature trees. Indirect costs cast a wider net. They include property taxes on the land where the asset is growing, depreciation on equipment used during the growth phase, utilities for irrigation, fuel for tractors, and repairs to barns or fencing that house developing animals. If an expense contributes to getting the asset to productive status, it is probably in.

Once capitalized, those costs come back to you through depreciation after the asset enters production, or as an offset against the sale price when you dispose of it. The tax benefit is deferred rather than lost. For a walnut orchard that will not produce for six or seven years, that deferral is long.

Interest on Money Borrowed to Fund the Growing Phase

Borrow to finance a crop or animal with a preproductive period over two years, and the interest on that debt faces its own capitalization requirement. Real property with a production period longer than two years is treated as “designated property,” and interest allocable to producing it must be capitalized.³ Growing crops and plants count as real property for this purpose, but only when the preproductive period exceeds two years. Annual crops financed with operating loans are not affected. Timber and evergreen trees more than six years old at harvest are carved out as well.⁴

Farmers planting new orchards or vineyards can end up capitalizing twice: the direct growing costs and the interest that funded them.

The Small-Farm Exemption

Even if you grow crops on the over-two-years list, you may still be exempt if your operation is small enough. For the 2026 tax year, a farming business with average annual gross receipts of $32 million or less over the prior three tax years is generally exempt from UNICAP entirely.⁵ The threshold is adjusted for inflation each year. For most family-scale orchards and vineyards, this exemption alone takes UNICAP off the table without any special election or trade-off.

The Election to Deduct Instead of Capitalize

Farmers above the gross receipts threshold who grow crops with a preproductive period beyond two years have one more option. A formal election under Section 263A(d)(3) lets you deduct preproductive-period expenses currently rather than capitalize them. You make it in the first tax year you engage in a farming business after December 31, 1986, simply by treating the expenses as deductible on your return.¹

Once made, the election can only be revoked with IRS consent, so it is effectively permanent. It is also unavailable to corporations, partnerships, and tax shelters that are required to use the accrual method.⁶ There is a specific carve-out for citrus and almond groves: even under the election, planting, cultivating, and developing costs during the first four tax years after the trees go in the ground must still be capitalized.¹

What the Election Costs You

The election is not free. Two conditions come with it, and either can wipe out the benefit of the earlier deductions.

First, you must switch to the Alternative Depreciation System for all farm property placed in service during any year the election is in effect. ADS uses straight-line depreciation with longer recovery periods. Farm machinery, for example, moves from a 7-year recovery period under the regular system to a 10-year period under ADS. Farm buildings stretch similarly. Over the life of a large equipment fleet, that slower pace reduces the present value of your depreciation deductions.¹

Second, any amounts you deducted that would otherwise have been capitalized are recaptured as ordinary income when you dispose of the plant. The plant is treated as depreciable property for recapture purposes, and the full amount you expensed is treated as if it were depreciation. On sale, that amount comes back at ordinary rates rather than capital gains rates.¹

The election tends to make sense for operations that need immediate cash-flow relief from heavy planting costs and plan to hold their orchards or vineyards for the long haul. If you are likely to sell within a few years, the recapture hit can erase the benefit.

Replanting After a Casualty

When plants bearing an edible crop for human consumption are destroyed by freezing temperatures, disease, drought, pests, or another casualty, replanting costs do not have to be capitalized. The exception applies as long as you replant the same type of crop, either on the same parcel or on another parcel of the same acreage in the United States.⁷ It is available whether or not you made the Section 263A(d)(3) election, and it sits on top of any casualty loss deduction for the destroyed plants themselves.

Reporting on Schedule F

How you report preproductive costs depends on which path you take. If you elect to deduct, you treat the expenses as current deductions on Schedule F the way you would any other farm expense. The IRS considers that treatment itself to be the election; no separate form or statement is required.⁶

If you capitalize, do not reduce your deductions on Schedule F lines 10 through 32e. Enter the total capitalized amount as a negative number on line 32f and write “263A” in the space to the left. That tells the IRS you properly excluded those costs from current deductions and added them to your asset basis.⁶

The common mistake here is straightforward: deducting preproductive costs on the return without realizing you have triggered the 263A(d)(3) election and its ADS and recapture consequences. Once the IRS sees those deductions on a return involving crops with a preproductive period over two years, the election is treated as made. You cannot later claim you did not intend to elect.

What Happens If You Get It Wrong

Incorrectly deducting costs that should have been capitalized rarely stops at an adjustment to a single year. An IRS examiner who finds the error has two main paths. The first is to require a change in accounting method, recalculating the correct treatment across open and closed years and producing a single catch-up adjustment that can drop a lump of additional income into the year of correction. The second is to let you keep the deductions by treating you as having made the 263A(d)(3) election, but only if you simultaneously switch all your farm assets to ADS depreciation going forward. If you already claimed accelerated depreciation on equipment placed in service during years you were improperly deducting preproductive costs, the election is considered invalid, and the accounting-method-change route is the only option.

Either way, the IRS will assess interest on any underpayment, and accuracy-related penalties may apply if the error is substantial. The best protection is plain recordkeeping: track which assets are in their preproductive period, document the costs allocated to each, and make sure your depreciation method matches the election you actually intended to make.

1
Office of the Law Revision Counsel. 26 USC 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses
2
Internal Revenue Service. Notice 2013-18 – Update of List of Plants With Preproductive Period in Excess of 2 Years
3
eCFR. 26 CFR 1.263A-8 – Requirement to Capitalize Interest
4
Internal Revenue Service. Interest Capitalization for Self-Constructed Assets
5
Internal Revenue Service. Revenue Procedure 2025-32
6
Internal Revenue Service. Instructions for Schedule F (Form 1040)
7
Office of the Law Revision Counsel. 26 US Code 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses