Managing farm depreciation: Jeff Tranel helps producers understand depreciation
Managing farm or ranch financials can be difficult, but learning the basics of depreciation can help producers ease the burden.
Jeff Tranel, Colorado State University agricultural and business management economist and member of the National Farm Income Tax Extension Committee, presented the “Managing Depreciation for Your Farm Business” webinar, arranged by the Let’s Grow Committee of American Sheep Industry Association and RightRisk Education Team, to explain depreciation and its impact.
“Providing a better understanding of depreciation to producers can put them in a better position to consult with a tax advisor to reach business and personal goals,” Tranel said.
Types of property
Tranel reviewed six types of depreciation generally used for business and personal use, like vehicles, computers and internet services.
Irrigation systems, wells, dams, ponds and terraces are not depreciable unless estimated lifespan can be determined.
“For buildings, single and multi-purpose distinctions are determined according to Internal Revenue Service rules,” Tranel commented, saying single-purpose buildings, like chicken coops, have shorter recovery periods than multi-purpose buildings, like sheds.
“Livestock used for breeding, draft and dairy are considered depreciable property, and the cost of purchasing, trucking and placing the animals in service can be depreciated,” he added.
Permanent improvements producers make to rented property is also depreciable, Tranel stated.
To be considered depreciable, property must be owned by the taxpayer, used in the business, have a measurable lifespan and be expected to last more than a year, Tranel explained.
Property starts depreciating when placed in service for a specific use, and depreciation ends when the property cost is fully recovered or the item is retired from service, he said.
“Most types of property depreciation deduct the cost of the asset. Deductions must be spread out over the time property is operational and be taken out annually,” Tranel added.
Under the Modified Acceleration Cost Recovery System (MACRS), the two systems for basis recovery are General Depreciation System (GDS) and Alternative Depreciation System (ADS). The systems determine recovery period and use a different method to estimate depreciation.
GDS has shorter recovery periods and is commonly used in farm and ranch businesses, Tranel stated, adding ADS is used for property utilized less than 50 percent of the time or when uniform capitalization rules are not applied.
“An additional 50 percent depreciation is allowed in GDS for qualified property, and generally, these properties have a long production period and a pre-productive time of more than two years, which is good for producers,” added Tranel.
Uniform capitalization rules apply to producers who produce real or tangible personal property or acquire property for resale. However, the rules don’t apply to acquired properties with average annual gross receipts of $10 million or less, for a three year tax period ending the year prior, Tranel explained.
“For managers who elect not to use uniform capitalization rules, ADS will be applied to all property placed in service the previous year,” he cautioned.
Conventions and methods
Within the two depreciation systems, three different conventions determine the number of months depreciation can be claimed for the year property is placed in service and the year property is retired.
The mid-month convention is used to depreciate non-residential property, residential rental property, railroad grading and tunnel boring, Tranel indicated.
“Mid-quarter conventions are used for property placed in service the last three months of the tax year and amounts to more than 40 percent of the total depreciable basis from property placed in service the entire year,” Tranel added, mentioning the most common convention is the half-year convention, which applies when the mid-month and mid-quarter methods do not.
“Producers should plan when to buy capital assets and place them in service to utilize the best convention for their business, he advised.
Under GDS, the 150 percent declining balance depreciation method is used to recover all farm and ranch business’ property basis.
Likewise, the straight-line method is used in both GDS and ADS, to compute depreciation. Straigh line depreciation divides original basis by the years allowed for recovery.
“Straight-line provides an equal amount of depreciation to be deducted every tax year during the recovery period,” he said, noting producers can switch from 150 percent declining balance method to straight-line method when the depreciation from the straight-line method provides an equal or greater deduction.
Tranel also reviewed the Section 179 deduction, which allows producers to recover all or part of qualified property basis, up to $510,000, by deducting the basis from the year property is placed in service.
Under this section, deductions for purchases totaling over $2 million in one year are limited, he added.
“Producers can elect to use Section 179 deductions or recover property costs using regular depreciation methods,” he stated.
To qualify for Section 179, property must be eligible, have been acquired for at least 50 percent business use and must be bought, he said, stating Section 179 cannot be used to reduce taxable income to zero or below.
“Oftentimes, receiving the highest possible tax deduction is thought to be the best decision,” he commented, adding, “Those decisions can cause financial problems for producers or higher tax liabilities in future years.”
Tranel insisted he is not a tax advisor and recommends producers choose the best option for their operations because specific depreciation systems or methods may work for one operation but not another.
Heather Loraas is assistant editor of the Wyoming Livestock Roundup and can be reached at firstname.lastname@example.org