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 or ranching. A broad discussion introducing the series of depreciation topics can be found here. This article discusses the 15-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 Assets with a Fifteen-Year Recovery Period
Examples of property employed in the conduct of farming or ranching businesses that have a fifteen-year recovery period are listed below. Table 1 illustrates MACRS GDS and ADS recovery periods for these listed agricultural assets. Under TCJA, 15-year recovery period assets must use 150 percent declining balance to calculate MACRS GDS depreciation, or may elect to use MACRS straight line or MACRS ADS.
Example 1. Roger purchased an 80-acre farm. Farm improvements included a tile drainage system; Roger allocated $15,000 to the drainage tile. Drainage tile is an asset within the fifteen-year recovery class and its first-year depreciation options are provided below.
- Under MACRS GDS 150 percent declining balance, half-year convention, the first year’s depreciation is $750 ($15,000 x 0.05).
- If elected, MACRS GDS straight-line depreciation over the fifteen-year recovery period yields a first-year $500 deduction [($15,000/15)/2].
- MACRS ADS has a twenty-year recovery period using straight-line depreciation. Therefore, the first year’s allowed depreciation amount is $375 [($15,000/20)/2].
Example 2. Louisa operates a large grain operation. Last year Louisa build a multi-purpose building to repair and store equipment. This year Louisa added a large paved lot at a cost of $30,000 immediately adjacent to her building. The parking lot is to support her farming operations as a dedicated pad to load equipment with seed, chemicals or fertilizer and as a place to wash and clean the equipment before switching operations. The parking lot/pad is a land improvement with a fifteen-year MACRS recovery period.
- If Louisa uses the 150 percent declining balance MACRS GDS assuming half-year convention, the first year’s depreciation is $1,500 ($30,000 x 0.05).
- If elected, MACRS GDS straight-line depreciation over the fifteen-year recovery period yields a first-year deduction of $1,000 [($30,000/15)/2].
- MACRS ADS has a 20-year recovery period using straight-line depreciation. Therefore, the first year’s allowed depreciation amount is $750 [($30,000/20)/2].
Example 3. Richard is a corn and soybean farmer. This year he was granted a permit to drill an irrigation well to service two low-pressure irrigation systems. The well was successfully drilled and pumps more than enough water to support the two irrigation systems. The cost of drilling and completing the 450-foot-deep well was $120 per foot or $54,000.
- Richard’s first-year depreciation using MACRS GDS 150 percent declining balance assuming half-year convention results in allowable depreciation of $2,700 ($54,000 x .05).
- Richard’s MACRS ADS depreciation for the first year would be $1,350 [$54,000/20)/2].
Example 4. Jasmine purchased a 120 acre farm this year. Jasmine with the help of her local NRCS office designs and constructs a terrace and grassed-waterway system on the farm to increase future productivity. The terraces and waterways were built at a total cost of $42,000 ($350/acre). This system has a cost-recovery period of fifteen years under MACRS GDS.
- Jasmine’s allowable first year depreciation using either MACRS GDS 150 percent declining balance is $2,100 ($42,000 x .05) assuming half-year convention.
- MACRS GDS straight-line depreciation allows $1,400 [($42,000/15)/2] as the first year’s depreciation amount assuming half-year convention.
- By contrast, the MACRS ADS system allows for $1,050 of first year’s depreciation assuming half-year convention [($42,000/20)/2].
Readers should note that bonus depreciation (discussed in a separate article) under IRC § 168(k) presumes that the farmer, rancher, 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 common depreciation outcomes allowed for the first year of the respective business properties. 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 items such as land improvements in these examples should consider financing issues. Typically, the loan structure should match the depreciable life; however, IRS allows a fifteen-year life for this class of property. Farmers or ranchers may look to industry volatility and choose a 30-year term for the loan for the land and combine needed land improvements but fifteen-years for depreciation of the land improvement(s). In doing so, a spike in income and self-employment taxes will result in years 16 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 (in the case of bonus depreciation) create a loss.
Generally, the fifteen-year recovery class for farm property provides marginal differences between the GDS alternatives, whereas the ADS class life is five years longer and provides 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 fifteen-year recovery class, should be considered for not only the current year’s income tax return, but also for the long-run implications to the business plan.