This article is part of a series in which depreciation of business or investment property is discussed. The focus is on agricultural business property used in the trade or business of farming, ranching or fisheries. A broad discussion introducing the series of depreciation topics can be found here. This article discusses the 10-year recovery period in the context of recovering the cost of such property placed into service, as well as business management decisions to consider in the near-term, as well as long-term potential outcomes.
In Appendix B of 2019’s IRS Publication 946, How to Depreciate Property, beginning on page 98 Table B-1 can be found. This table is a listing of property which provides guidance to the class life. After Table B-1, Table B-2 provides more detailed guidance relative to class, class-life and recovery period for depreciation purposes. Table B-2 begins on page 99. Readers will find that agricultural assets are listed in classes 01.1 through 01.4, however, the list is not all-inclusive relative to property employed in agriculture and ranching.
Common Agricultural/Fishery Assets with a Ten-Year Recovery Period
Examples of property employed in the conduct of farming or ranching businesses that fit into the 10-year recovery period are listed below. Table 1 illustrates MACRS GDS and ADS recovery periods for listed agricultural assets.
In Appendix B, Table B-1, IRS Publication 946, How to Depreciate Property, vessels such as fishing boats have a GDS recovery period of 10 years and an ADS recovery period of 18 years. Vessels are in the 00.28 asset class; this is useful for the fishing industry to correctly depreciate acquired boats and fishing vessels.
Example 1. Eugene operates a Holstein dairy farm. This year Eugene built and placed into service a new dairy milking parlor at a cost of $1.5 million. A milking parlor is an example of a “single purpose” structure as its intended purpose is for one activity only, that is, milking cows. Therefore, the milking parlor’s recovery period is 10 years.
- Under MACRS GDS 200 percent declining balance, half-year convention, the first year’s depreciation is $150,000 ($1.5 million x 0.10).
- If Eugene elects 150 percent declining balance MACRS GDS assuming half-year convention the first year’s depreciation would be $112,500 ($1.5 million x 0.075).
- If elected, MACRS GDS straight-line depreciation over the 10-year recovery period would yield a $75,000 ($1.5 million x 0.05) first year deduction.
- MACRS ADS has a fifteen-year recovery period using straight-line depreciation. Therefore, the first year’s allowed depreciation amount is $50,000 ($1.5 million x 0.0333).
Hog and poultry production buildings are additional examples of single-purpose agricultural structures. Tax law allows for a small area within the structure to be used for managing care of animals, such as a “medication pen” which does not violate the “single-purpose” use. Occasionally, “flat hay storage” may qualify, however, to be a ten-year single purpose structure, then only hay can be stored in the structure. Tax professionals should be sufficiently cautious in asking questions to help make the correct depreciation determination regarding agricultural structures.
Example 2. Jessica owns and operates a wholesale nursery business. She built two greenhouses (horticultural single-purpose structures) as part of her business expansion plans at a cost of $100,000 each. The first greenhouse is used to grow and cultivate plants for ultimate sale to Jessica’s retail clients. In a response to growing demand, Jessica allocates a percentage of the second greenhouse to retail sales space.
The first greenhouse is a single-purpose structure which qualifies for the ten-year recovery period. Under MACRS GDS 200 percent declining balance, her first year’s depreciation allowed as a deduction is $10,000 ($100,000 x 0.10) assuming half-year convention. For tax management and business planning purposes Jessica has similar options as Eugene in Example 1.
However, Jessica’s second greenhouse poses a problem. Because Jessica allocates a percentage of space to retail activities, this greenhouse is a multi-purpose agricultural structure and has a twenty-year recovery period under MACRS GDS.
Tax professionals must determine, to some level of comfort, the intent of their client. Based on the fact pattern being presented, if Jessica’s tax adviser were consulted prior to the construction of the second greenhouse, a suggestion to build a small separate structure for the retail needs may have resulted in a better outcome for Jessica’s business.
Example 3. Amed is a fourth-generation olive grower in California. This year he places into service a new orchard of “super densely planted” olive trees. Amed capitalized his pre-productive expenses of $6,500 per acre for the fifteen-acre planting, thus realizing a total cost of $97,500 for the trees. Under MACRS, GDS 200% declining balance and half-year convention, Amed’s depreciation this year is $9,750 ($97,500 x 0.10).
If Amed elects to use MACRS ADS recovery period of 15 years, then his first year’s allowable depreciation is $3,250 [($97,500/15)/2] assuming half-year convention.
Amed also has available to him the other MACRS GDS options as illustrated in Example 1 should he elect to do so.
Example 4. Randy is a flounder fisherman. This year he bought a new 85-foot fishing vessel to replace his old less efficient boat. The new vessel has increased capacity and allows Randy and his crew to stay out overnight if necessary. Randy has a fishing permit to operate in U.S. waters off the East Coast. Randy paid $850,000 for the new boat.
Due to the volatility of the industry, Randy elects to use MACRS ADS. The recovery period is 18 years, resulting in $23,611.11 of allowable first-year depreciation, assuming half-year convention [($850,000/18)/2]
Randy does have options under MACRS GDS like Example 1.
Readers should note that bonus depreciation (discussed in a separate article) under IRC § 168(k) presumes that the farmer, rancher, or fishermen uses bonus and deducts 100 percent of the cost of property placed into service. Examples 1 through 4 assume the illustrated taxpayers elect out of bonus depreciation as part of their income tax planning for their respective farm businesses.
Tax Planning / Farm Management Implications
The four examples above illustrate typical depreciation outcomes allowed for the first year of the respective business properties. Commonly, farmers and ranchers are sensitive to the current tax year’s income and self-employment tax obligations with a goal to minimize the tax and maximize after-tax income.
Depreciation decisions relative to single-purpose agricultural or horticultural structures should perhaps consider financing issues. Generally, the loan structure should match the depreciable life, however, IRS allows a ten-year life for this class of property. Farmers or ranchers (and fishermen) may look to industry volatility and choose a fifteen-year term for the loan but ten-years for depreciation. In doing so, a spike in income and self-employment taxes will result in years 11 and following, all other things equal. The increased tax liability can cause cash flow problems for these businesses.
Regardless, it is prudent for farmers and ranchers to consider long-term business goals and objectives in a systems approach to management of the agricultural business. The answer to what is the “best” decision will depend upon where the farm or ranch finds itself on the business life-cycle curve. Beginning farmers may be inclined, and rightfully so, to protect cash and use the tax code to accomplish this goal. Using bonus depreciation [IRC §168(k)] or the “expense election” under IRC section 179 (both discussed in separate articles) can reduce farm income to zero or even create a loss.
Generally, the ten-year recovery class for farm property provides marginal differences between the GDS alternatives, whereas the ADS class life is five years longer, providing for a larger difference. However, the choice between the two may fit into the farmer’s long-term business model.
Farmers and ranchers will, depending on the business model being undertaken, have choices to make when purchasing property for use in their businesses. Depreciation options, even for the ten-year recovery class, should be considered for not only the current year’s income tax return, but also for the long-term impacts on the business plan.
Resources for Reference
IRS Publication 946, How to Depreciate Property