Current law allows those in the business of farming to deduct certain expenses for soil or water conservation, prevention of erosion of land use in farming, or endangered species recovery. Taxpayers who are not in the business of farming (including those who rent their land to a tenant under a cash rent lease) must capitalize these expenses by adding them to the basis of the land. Expenses associated with implementing a conservation practice include (but are not limited to) costs for the following:
- Earthmoving for leveling, grading, terracing, contour furrowing, and restoration of soil productivity
- Construction of diversion channels, drainage ditches, irrigation ditches, earthen dams, ponds, water way outlets, watercourses, and other similar land features
- Eradication of brush (recovery of pasture or field borders)
- Planting of windbreaks
- Meeting the needs of a site-specific management action recommended in recovery plans approved pursuant to the Endangered Species Act of 1973 (ESA)
Conservation expenses are deductible by the farmer only if they are consistent with a plan approved by the Natural Resources Conservation Service (NRCS) of USDA or a comparable state agency. Farmers must keep a copy of the plan with their books and records to support the deduction in the event of an audit. Farmers cannot deduct expenses to drain or fill wetlands or to prepare land for center-pivot irrigation systems. These expenses must instead be capitalized.
The farmer’s annual allowable deduction cannot exceed 25 percent of gross income from farming, which includes the amount on Line 9 of Schedule F, as well as gains from sales of draft, breeding, or
dairy livestock. Gross farm income for this purpose does not include gain from the sale of farm machinery or from the sale of land used in farming. If the 25 percent limitation does not allow for the full deduction of expenses in the current year, any excess may be carried forward to subsequent years, subject to the 25 percent limitation in those years. Cost-share payments are generally included in farm income and reported on Line 4b as taxable amounts.
Example 1. Reggie lives in the low country and implements a soil and water conservation plan to help manage spring flooding and protect water resources for the future. He does not raise any livestock. Reggie’s conservation plan is approved by NRCS and his state’s Department of Environmental Quality. He receives $65,000 in cost-share funds to implement his plan. Reggie spends $92,000 and completes his plan this year. Reggie must include the $65,000 cost share payment in income on line 4b. Due to the 25 percent limitation, Reggie is able to deduct $81,250 of his costs this year ($325,000 * 0.25). He will carry the balance of the deduction, $10,750, forward to the following year.
Recapture
If the farmer sells the land for which the soil and water conservation deduction was taken, there may be recapture of the deduction, which means that the farmer will treat part or all of the gain as ordinary income. If the landowner sells the land within 5 years of acquiring it, the lesser of the gain realized or 100% of the section 175 deductions for the land is treated as ordinary income. If the landowner sells the land within the 6th through 9th year after acquiring it, the portion of the conservation deduction that is recaptured is reduced by 20% a year for each year or part of a year the landowner held the land after the 5th year. If the landowner disposes of the land 10 or more years after he or she acquired it, none of the conservation deduction is recaptured—the entire gain is a section 1231 gain.
The Center for Agricultural Law and Taxation is a partner of the National Agricultural Law Center (NALC) at the University of Arkansas System Division of Agriculture, which serves as the nation’s leading source of agricultural and food law research and information. This material is provided as part of that partnership and is based upon work supported by the National Agricultural Library, Agricultural Research Service, U.S. Department of Agriculture.