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 five-year recovery period property, including short-term and long-term business management decisions to consider.
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. Following 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 Five-Year Recovery Period
Examples of property employed in the conduct of farming or ranching businesses that have a 5-year recovery period are listed below. Table 1 illustrates MACRS GDS and ADS recovery periods for the listed assets.
Depreciation Examples
Example 1. George operates a dairy farm. In April, George purchases 50 springing heifers to bring into his milking herd. George pays $1,250 per head. Because George is the first farmer to use these springing heifers in a dairy business these animals qualify for 200-percent declining balance under MACRS GDS. Therefore, under half-year convention, George’s allowable depreciation in the first year is $12,500 ($62,500 x 0.200).
Example 2. Using the same fact pattern as in Example 1, George elects, for tax management purposes, to use 150-percent declining balance under MACRS GDS. Therefore, his allowable depreciation in the first year is $9,375 ($62,500 x 0.15) which is $3,125 less. If, George was subject to the Alternative Minimum Tax (AMT) no change in his depreciation deduction need be made; however, he would need to use the 150-percent declining balance method for AMT purposes.
Example 3. Consuela operates a cattle ranch. In July, Consuela buys a new forage chopper for $150,000. Under TCJA, since the forage chopper is new, meaning Consuela is the first to place the forage chopper into service, the recovery period for new equipment is five years. Therefore, under half-year convention and 200 percent declining balance, the first year’s allowable depreciation is $30,000 ($150,000 x 0.20).
Had the forage chopper been used, then the recovery period is 7 years, not five. Thus, using 200 percent declining balance the allowable first year’s depreciation is $21,435 ($150,000 x 0.1429). Seven-year assets are discussed in a separate article.
Example 4. After consulting with her tax preparer, Consuela, in Example 3, decides to use the ADS recovery period to depreciate the new forage chopper. In this case, the recovery period is now 10 years using straight-line half-year convention. The allowable first year’s depreciation is $7,500 ($150,000 x 0.05).
Example 5. Mikael purchased a used ¾ ton four-wheel drive crew cab pickup for use in his farm business. The pickup is used 100 percent in the business; Mikael paid $35,000 for the vehicle. The gross vehicle weight is 10,000 pounds and is rated to tow 14,000 lbs. Mikael’s pickup has a recovery period of 5 years for both GDS and ADS purposes because the pickup weighs less than 13,000 lbs. Therefore, under GDS, his first year’s depreciation is $7,000 ($35,000 x 0.20) using half-year convention; and, under ADS it’s $3,500 ($35,000 x 0.10).
Readers should note that bonus depreciation (discussed in separate article) under IRC § 168(k) presumes that the farmer or rancher uses bonus and deducts 100 percent of the cost of property in the year it is placed into service. Examples 1 through 5 assume the farmers elect out of bonus depreciation as part of their income tax planning for their respective farm businesses.
Tax Planning / Farm Management Implications
The five examples illustrate common depreciation outcomes allowed for the first year for the respective business properties. Clearly, the contrast between MACRS, GDS, and ADS recovery periods can be significant as illustrated in Example 5. These examples highlight 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 even create a loss.
Generally, the 5-year recovery class for farm property provides a marginal difference between the GDS or ADS depreciation systems, except in the case of new farm equipment where the recovery period under ADS is 5 years longer as illustrated in Examples 3 and 4. 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 five-year recovery class, should be considered for not only the current year’s income tax return, but also for the long-term implications on the business plan.
Resources for Reference
IRS Publication 946, How to Depreciate Property