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 20-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 Twenty-Year Recovery Period
Examples of property employed in the conduct of farming or ranching businesses that fit into the twenty-year recovery period are listed below. Table 1 illustrates MACRS GDS and ADS recovery periods for these listed agricultural assets. Fifteen- and twenty-year asset classes must use 150 percent declining balance under GDS, or the farmer/rancher may elect to use MACRS straight line or MACRS ADS.
Example 1. Cecilia built a multi-purpose farm building which was 60 feet wide and 100 feet long. The building’s cost, including foundation slab, electric service and wiring, and plumbing was $120,000 ($20/sq. ft). Therefore, the first year’s allowed depreciation amount is $4,500 ($120,000 x 0.0375) assuming MACRS GDS 150 percent declining balance and half-year convention.
- If Cecilia elects to use MACRS straight-line, her first year’s depreciation would be $3,000 [($120,000/20)/2] all other things equal.
- MACRS ADS, if elected by Cecilia, will result in a first year’s depreciation calculation of $2,400 [($120,000/25)/2].
Example 2. Jorge purchased a farm this year. The farm improvements include a 3-bedroom house which Jorge plans to provide to one of his employees as part of his employment compensation package. Because Jorge operates a farm and his farm employee will live in the house, the house is treated as a farm building with a 20-year recovery period. The farm appraisal, required for financing the farm purchase, values the house at $95,000.
- MACRS GDS 150 percent declining balance, assuming half-year convention, results in $3,562.50 for the first year’s depreciation deduction.
- MACRS straight line results in $2,375 for the first year’s depreciation assuming half-year convention.
- MACRS ADS has a 25-year recovery period using straight-line depreciation. Therefore, the first year’s allowed depreciation amount is $1,900 [($95,000/25)/2] assuming half-year convention.
Example 3. Jorge, from Example 2, plans to hire more farm employees. He plans to use the recently purchased farm as a place to locate his employees. For his newly hired employee, Jorge purchases a mobile home and moves it onto the purchased farm property.
Page 43 of the 2019 Farmer’s Tax Guide suggests that if Jorge’s plans are to move this mobile home in the future and, therefore, leaves the wheels attached to the axles, the mobile home has a recovery period of 7 years under MACRS GDS (10 years MACRS ADS). This also assumes temporary connections for electricity, plumbing and sewage.
If, however, Jorge moves the mobile home on to the purchased farm property and sets it up on a permanent foundation, removes the wheels and makes permanent connections to electricity, plumbing and sewage, then the mobile home is like the house in Example 2 and is treated as a 20-year MACRS GDS asset (25 years MACRS ADS).
County zoning laws may require that the mobile homes, as described in Example 3, have permanent fixtures of foundation, electricity, plumbing and sewage. If used in a farming business, the 20-year recovery period will apply. Other agencies may also require similar permanent fixtures to the mobile home.
Example 4. Tim inherited a farm from his late grandfather’s estate this year. On the farm was a 100-year-old barn and lean-to which was in good repair. The estate appraisal valued the structure at $35,000. Tim plans to use the barn to store small equipment and supplies for his growing vegetable operation. The barn, being a multi-purpose agricultural structure, has a twenty-year recovery period.
- Tim’s allowable first year depreciation using the MACRS GDS 150 percent declining balance is $1,312.50 ($35,000 x 0.0375) assuming half-year convention.
- MACRS GDS straight-line depreciation allows $875 [($35,000/20)/2] as the first year’s depreciation deduction assuming half-year convention.
- If elected, MACRS ADS allows for $700 of first year’s depreciation assuming half-year convention [($35,000/25)/2].
Readers should note that bonus depreciation (discussed in a separate article) under IRC § 168(k) presumes that the farmer or 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. Twenty-year recovery class assets have the longest class life eligible for bonus depreciation.
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 agricultural structures in these examples should consider financing issues. Typically, the loan structure should match the depreciable life; however, IRS allows a twenty-year life for this class of property. Farmers or ranchers may look to industry volatility and choose a 30-year or more term for the loan for the land and improvements. Using a 30-year term will create debt structure which is typical for real property investment and match up with farm structure depreciation.
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 (in the case of bonus depreciation).
Generally, the twenty-year recovery class for farm buildings provides marginal differences between the GDS alternatives, whereas the ADS class life of five years longer 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 twenty-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.
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