What is your goal in the tax planning process? Most responses are to pay as few taxes as possible, but the “reverse” may also be true, and that is to maximize your after-tax wealth. While those may not always be the perfect yin and yang of Schedule F preparation, effective tax planning should have the goal of maximizing your bank account when all taxes are paid. Most farmers have M.D. degrees (Masters’ of Deductions), but there are many other tax provisions that a good tax planner can help with the goal of increasing wealth.
Depreciation and expensing are keys to successful tax planning, and for many years, farmers lived on their depreciation. Recently the Internal Revenue Code (IRC) Section 179 expensing provision has been one that many farmers have exploited to their advantage and to fill their machine shed. In his annual tax guide for farmers, Purdue economist George Patrick says many recent changes have occurred with Section 179. The limit was expanded to $500,000 and 2011 is the final year for that, which allows farmers to treat purchases as an expense, rather than an appreciable capital purchase. Beginning with 2012 it drops back to $125,000.
Working with your tax advisor, you will have the time after the close of the tax year to make an expensing election on capital purchases, and that provides great flexibility for farmers, says Patrick. To qualify for Section 179 expensing, the following must happen:
- The property must be used in trade or business, such as farm equipment, livestock for breeding, grain storage equipment or field tile. A multi-purpose structure such as a machine shed is not eligible, along with farmland.
- The property must be purchased, and not leased, and may be new or used, but not inherited.
- Traded equipment can be eligible, but only the amount of any cash that is added to equipment traded in is eligible.
- There is also a $2 million dollar maximum that is eligible.
- The expensing is also limited to any taxable income, and cannot be surpassed to generate a loss. However, farm income can be added to off farm income within the household to be eligible for the expensing reduction.
- The expensing can be applied to one large item or several small items for write off. Patrick says, “Generally, it will be more advantageous to allocate the expensing deduction to longer-lived assets and to assets that are likely to be kept in the business for their entire depreciable life.” He also says the expensing action can be applied in an amended tax return, even if it was not used in the original tax return.
In addition to the Section 179 expensing, the IRS will also allow additional first-year depreciation, equal to 100% of qualifying property, after the Section 179 expensing is applied. Eligibility requires the property be placed into service before Jan. 1, 2012. If the service date is delayed to sometime in 2012, the rate declines to 50%. The property must meet all of the following:
- The original use must begin with the taxpayer, which requires the property to be new.
- The asset must be eligible for the Modified Cost Recovery System with a recovery period of less than 20 years.
- The property must be put into service before Jan. 1 2013, but some property is eligible for a longer period.
- Use of the Alternative Depreciation System is not required.
The Section 179 expensing deduction is limited to active businesses, and while it can be carried bay two years or forward five years, Patrick says, “Good tax management will generally avoid carry forward and net-operating loss situations.” Cash rent landlords are not eligible for Section 179 expensing.
Section 179 expensing has become a popular tax-management tool, since capital assets can be treated as an expense, and not depreciated over time. That allows the deduction to be fully made in the first year of ownership, but it is limited to equipment and breeding stock, but not multi-purpose buildings. Additional first-year depreciation can be accomplished, but all of the provisions should be made with the advice and counsel of a tax specialist.