n-09-64.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Proposed Revenue Ruling Regarding Depreciation of Ethanol Plants

Notice 2009-64

This notice provides a proposed revenue ruling concerning the depreciation of
tangible assets that are used in converting corn to fuel grade ethanol.
The proposed revenue ruling concludes that the appropriate depreciation
classification for these assets is asset class 49.5, Waste Reduction and Resource
Recovery Plants, of Rev. Proc. 87-56, 1987-2 C.B. 674, as clarified and modified by
Rev. Proc. 88-22, 1988-1 C.B. 785, for purposes of determining depreciation under
§ 168 of the Internal Revenue Code. This conclusion is based on the asset class
description, the applicable definition of biomass, and the fact that conversion of biomass
into a liquid fuel is the primary business activity and use of the facility. It is expected
that this depreciation classification would apply to assets placed in service on or after
the publication of a final revenue ruling. Consequently, the Internal Revenue Service
will not require taxpayers to adopt this depreciation classification for tangible assets
used in converting biomass to a liquid fuel such as fuel grade ethanol that are placed in
service prior to the publication of a final revenue ruling.

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The Service and Treasury Department request public comments regarding the
proposed revenue ruling. A final revenue ruling will not be issued until the comments
have been considered. All comments will be available for public inspection and
copying.
Comments must be submitted in writing on or before November 23, 2009, and
should include a reference to Notice 2009-64. Submissions should be sent to:
Internal Revenue Service
Attn: CC:PA:LPD:PR (Notice 2009-64), Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044
Submissions also may be hand delivered Monday through Friday between the hours of
8 a.m. and 4 p.m. to: CC:PA:LPD:PR (Notice 2009-64), Courier’s Desk, Internal
Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC. Alternatively,
comments may be submitted electronically directly to the Service via the following e-
mail address: Notice.comments@irscounsel.treas.gov
. Please include “Notice 2009-
64“ in the subject line of any electronic communication.
PROPOSED REVENUE RULING
Rev. Rul. [XXXX-XX]
ISSUE
What is the proper asset class under Rev. Proc. 87-56, 1987-2 C.B. 674, as

3
clarified and modified by Rev. Proc. 88-22, 1988-1 C.B. 785, for the depreciation of
tangible assets that are used in converting corn to fuel grade ethanol?
FACTS
Taxpayer owns a facility operated primarily to produce fuel grade ethanol.
Ethanol is a colorless, flammable liquid that is an organic chemical, and a high octane
alternative fuel source. Taxpayer produces ethanol by fermenting starch from corn.
Taxpayer uses a dry milling process to produce fuel grade ethanol. Taxpayer
grinds the corn into flour, mixes the resulting corn flour with water, increases the
temperature, and adds enzymes to convert the starch in the solution to simple sugars.
Taxpayer feeds the resulting mash (water, sugars and non-convertible solids) into
fermentation tanks where yeast is added. Over a period of several days the yeast
metabolizes the sugars into ethanol and carbon dioxide (CO
2
)
.
The CO
2
produced
during fermentation may be collected, compressed, and sold as a by-product.
Taxpayer then sends the solution to distillation columns to separate the ethanol
from the solids and water. After distillation, part of the output is further processed by
dehydration to increase alcohol content by using molecular sieves that separate the
remaining water molecules from the ethanol. Once the dehydration is complete, the fuel
grade ethanol is blended with 2 to 5 percent denaturant (such as natural gasoline or
unleaded gasoline) and sent to storage pending sale.
Taxpayer also processes the solids and other liquids derived from the distillation
to produce and sell distillers grains, an animal feed supplement. More than 50 percent
of the economic output at Taxpayer’s facility is from fuel grade ethanol production.

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LAW
Statutory Scheme
Section 167(a) of the Internal Revenue Code provides that there shall be allowed
as a depreciation deduction a reasonable allowance for the exhaustion and wear and
tear of property used in a trade or business or held for the production of income.
The depreciation deduction provided by § 167(a) for tangible property placed in
service after 1986 generally is determined under § 168, which prescribes two methods
of accounting for determining depreciation allowances: (1) the general depreciation
system in § 168(a); and (2) the alternative depreciation system in § 168(g). Under
either depreciation system, the depreciation deduction is computed by using a
prescribed depreciation method, recovery period, and convention.
The applicable recovery period for purposes of either § 168(a) or § 168(g) is
determined by reference to class life or by statute. Section 168(i)(1) provides that the
term “class life” means the class life (if any) that would apply to any property as of
January 1, 1986, under former § 167(m) as if it were in effect and the taxpayer had
made an election under that section. Prior to its revocation, § 167(m) provided that if a
taxpayer elected the asset depreciation range system of depreciation, the depreciation
deduction would be computed based on the class life prescribed by the Secretary that
reasonably reflected the anticipated useful life of that class of property to the industry or
other group.
Primary Use Test

Section 1.167(a)-11(b)(4)(iii)(b
) of the Income Tax Regulations provides rules for

5
classifying property under former § 167(m) and, under these rules, property is included
in the asset class for the activity for which the property is primarily used (the “primary
use” test). Property is classified according to its primary use even though the activity for
which the property is primarily used is insubstantial in relation to all the activities of the
taxpayer.
Recent appellate decisions discuss the “primary use” standard for asset
classification under § 1.167(a)-11(b)(4)(iii)(b
). See, e.g., Clajon Gas Co, L.P. v.
Commissioner, 354 F.3d 786 (8
th
Cir. 2004). Courts have concluded that the actual
purpose and function of an asset determines its asset class (a use-driven functional
standard) rather than the terminology used to describe an asset by its owners or others.
Asset Classes
Rev. Proc. 87-56 sets forth the class lives of property that are necessary to
compute the depreciation allowance under § 168. This revenue procedure establishes
two broad categories of depreciable assets: (1) asset classes 00.11 through 00.4, which
consist of specific assets used in all business activities (asset categories); and (2) asset
classes 01.1 through 80.0, which consist of assets used in specific business activities
(activity categories). The same item of depreciable property may be classified in both
an asset category and an activity category, in which case the item is generally classified
in the asset category. See
Norwest Corporation & Subsidiaries v. Commissioner, 111
T.C. 105, 162 (1998).
Asset class 49.5 of Rev. Proc. 87-56, Waste Reduction and Resource Recovery
Plants, includes assets used in the conversion of refuse or other solid waste or biomass

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to heat or to a solid, liquid, or gaseous fuel. This asset class also includes all process
plant equipment and structures at the site used to (1) receive, handle, collect, and
process refuse or other solid waste or biomass to a solid, liquid, or gaseous fuel or (2)
handle and burn refuse or other solid waste or biomass in a waterwall combustion
system, oil or gas pyrolysis system, or refuse derived fuel system to create hot water,
gas, steam, or electricity. Asset class 49.5 also includes material recovery and support
assets used in refuse or solid refuse or solid waste receiving, collecting, handling,
sorting, shredding, classifying, and separation systems. Asset class 49.5 does not
include any package boilers, or electric generators and related assets such as
electricity, hot water, steam and manufactured gas production plants classified in
classes 00.4, 49.13, 49.221 and 49.4 of Rev. Proc. 87-56. Asset class 49.5 includes,
however, all other utilities such as water supply and treatment facilities, ash handling
and other related land improvements of a waste reduction and resource recovery plant.
Assets in class 49.5 have a recovery period of 7 years for purposes of § 168(a) and 10
years for purposes of § 168(g).
Asset class 28.0 of Rev. Proc. 87-56, Manufacture of Chemicals and Allied
Products, includes assets used to manufacture basic organic and inorganic chemicals;
chemical products to be used in further manufacture, such as synthetic fibers and
plastics materials; and finished chemical products. This asset class also includes,
among other things, all land improvements associated with plant site or production
processes, such as effluent ponds and canals, provided such land improvements are
depreciable but does not include buildings and structural components as defined in §

7
1.48-1(e). Asset class 28.0 does not include assets used in the manufacture of finished
rubber and plastic products or in the production of natural gas products, butane,
propane, and by-products of natural gas production plants. Assets in class 28.0 have a
recovery period of 5 years for purposes of § 168(a) and 9.5 years for purposes of §
168(g).
Rev. Rul. 77-63, 1977-1 C.B. 60, addresses the question of whether assets used
to produce alumina are classified in asset class 33.2, Manufacture of Primary
Nonferrous Metals, despite the fact that production used chemical processes. The
chemical processes were part of the taxpayer’s overall process of producing semi-
finished and finished aluminum products from bauxite ore that the taxpayer mined.
Asset class 33.2 includes assets used in the smelting, refining, and electrolysis of
nonferrous metals from ore. Rev. Rul. 77-63 concludes that the chemical processes
used to produce the alumina were an integral part of refining of the nonferrous metal
and further concludes that all of the assets used in the processing of the bauxite ore into
primary aluminum (basic metal), including those used in the chemical processes to
produce alumina, are classified in asset class 33.2. However, the revenue ruling
provides that assets used to process the alumina for use in activities other than those
required to produce the basic metal should be classified in other asset classes.
ANALYSIS
Asset class 49.5 specifically applies to assets used in the conversion of biomass
to a liquid fuel. For purposes of asset class 49.5, the term “biomass” means any
organic substance other than oil, natural gas, or coal, or product of oil or natural gas or

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coal. This definition of biomass is consistent with the definition in the energy credit
provisions that were enacted near the time asset class 49.5 was first established in
1979 by Rev. Proc. 79-26, 1979-1 C.B. 566. See
§ 48(l)(15)(B)(i), (l)(3)(B) as in effect
on the day before the date of enactment [11/5/90] of the Revenue Reconciliation Act of
1990, Pub. L. 101-508. The depreciation and the energy credit provisions are both
based on cost recovery concepts.
The corn used in Taxpayer’s facility is biomass, that is, an organic substance
other than oil, natural gas, coal, or a product thereof. Likewise, the fuel grade ethanol
produced from corn (biomass) at Taxpayer’s facility is liquid fuel for purposes of asset
class 49.5.
Asset class 28.0 of Rev. Proc. 87-56, which includes assets used to
manufacture basic chemicals, is not the appropriate asset class for Taxpayer's
depreciable tangible assets that are used in converting corn to fuel grade ethanol, even
though ethanol is an organic chemical. The individual, intermediate processes within
Taxpayer's facility, particularly distillation and dehydration, may be similar or identical to
the processing steps that take place in the manufacture of chemicals. However, the
mere use of a chemical process in the production of a product does not require an
activity to be classified as chemical manufacturing. In Rev. Rul. 77-63, producing
alumina by a chemical reaction as a step in the nonferrous metal refining process did
not preclude classification in the asset class that specifically applies to manufacturing
primary nonferrous metals. Similarly, converting corn, a biomass, to fuel grade ethanol,
a liquid fuel, by chemical processes does not preclude classification in the asset class

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that specifically applies to the conversion of biomass to fuel.
Further, Taxpayer is primarily engaged in producing fuel grade ethanol (liquid
fuel) from corn (biomass) at this facility. Under the “primary use” test of § 1.167(a)-
11(b)(4)(iii)(b
), Taxpayer's activity is described in asset class 49.5.
HOLDING
The proper asset class under Rev. Proc. 87-56 for depreciation of tangible assets
used in converting corn to fuel grade ethanol is asset class 49.5 (other than § 1250
property not described in asset class 49.5 and assets classified in asset classes 00.11
through 00.4 of Rev. Proc. 87-56).
PROSPECTIVE APPLICATION
Pursuant to § 7805(b)(8), the Internal Revenue Service will not apply the holding
in this revenue ruling to tangible assets that are used in converting biomass to a liquid
fuel such as fuel grade ethanol that a taxpayer places in service before [INSERT
PUBLICATION DATE OF FINAL REVENUE RULING].
DRAFTING INFORMATION

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The principal author of this notice is Ruba Nasrallah of the Office of the Associate
Chief Counsel (Income Tax & Accounting). For further information regarding this notice,
contact Ms. Nasrallah on (202) 622-4930 (not a toll-free call).