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 three-year recovery period property 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 Fitting into the Three-Year Recovery Period
Examples of property employed in the conduct of farming or ranching businesses that fit into the 3-year recovery period are listed below. Table 1 illustrates MACRS GDS and ADS recovery periods for the listed assets.
Depreciation Examples
Example 1. Ivan operates a farrow-to-weaning swine farm. In March Ivan purchases 100 gilts to bring into his swine breeding herd. Ivan pays $250 per head. Because Ivan is the first farmer to use these young breeding swine in a farm business these animals qualify for 200-percent declining balance under MACRS GDS. Therefore, under the half-year convention, Ivan’s allowable depreciation in the first year is $8,332.50 ($25,000 x 0.3333).
Example 2. Using the same fact pattern as in Example 1, Ivan elects, for tax management purposes, to use 150-percent declining balance under MACRS GDS. Therefore, his allowable first- year depreciation is $6,250 ($25,000 x 0.25) which is $2,083.50 less. If, Ivan was subject to the Alternative Minimum Tax (AMT) he would be required to use the 150-percent declining balance method for that purpose.
Example 3. All ‘Bout Cattle, LLC (ABC) owns several farms which supply corn silage to nearby feedlots. ABC uses over-the-road tractors (semi-tractors) to pull walking-floor trailers used to deliver chopped silage to their feedlot clients. In August, ABC bought new semi-tractors at a total cost of $800,000 and placed them into service. ABC chooses to use MACRS GDS straight-line depreciation to recover the cost of these semi-tractors. Therefore, the allowable first-year depreciation deduction is $133,336 ($800,000 x 0.166670) under the half-year convention.
Example 4. After consulting with its CPA, ABC in Example 3 decides to use the ADS recovery period to depreciate its semi-tractors. In this case, the recovery period is 4 years using straight-line. The allowable first-year depreciation is $100,000 ($800,000 x 0.125).
Example 5. Eli uses draft horses to provide power for his tillage, planting and harvest operations on his farm. In April of this year, Eli purchased a matched set of 13-year old Belgian geldings at a cost of $12,000 to replace his Shire team which he retired. Because these draft horses are older than 12 years when Eli places them into service on his farm, the MACRS GDS recovery period is three years; and, therefore, the first year’s depreciation is $4,000 ($12,000 x 0.3333) using 200-percent declining balance and mid-year convention.
However, if Eli elected to use ADS, the recovery period for these draft animals significantly increases from three to 10 years. As a result, the first year’s allowed depreciation would be $600 [$12,000 x (0.10/2)].
Tax Planning / Farm Management Implications
These five examples illustrate common depreciation outcomes allowed for the first year of the respective business properties. Clearly, the contrast between MACRS GDS and ADS recovery periods are more significant in Example 5 due to the seven-year difference. Example 5 highlights the type of decisions farmers and ranchers make in consultation with their tax professionals relative to the amount of first-year allowable deductions, but also how that decision will play out over the course of the chosen recovery period. 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.
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 (in the case of bonus depreciation) even create a loss.
Generally, the 3-year recovery class for farm property provides little difference between the GDS or ADS depreciation systems, except in the case of horses. However, the choice between the two may fit into the farmer’s long-term business model.
Conclusion
Farmers and ranchers will, depending on the business model being undertaken, have choices to make when purchasing property to use in their businesses. Depreciation options, even for the three-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.
Resources for Reference
IRS Publication 946, How to Depreciate Property