The major tax law changes that took effect at the start of 2018 included numerous provisions that affect the farming industry. While we realize some of the following is complex, our goal is to make you aware of changes that may be impacting your farming operation and tax plan.
After reviewing this information, we suggest setting up a time in the next month or so to discuss the impact of the new laws on your operation and to update your tax plan before the end of the year.
Like-Kind Exchanges of Real Property
Farmers will not be able to replace aging farm equipment with new purchases on a tax-free basis. So, for example, if you trade-in a piece of equipment toward the purchase of new equipment, the trade-in amount will be handled as a sale.
Under prior law, no gain or loss was recognized if property held for productive use in a trade or business or for investment was exchanged for property of “like kind” which was to be held for productive use in a trade or business or for investment. This allowed farmers to trade equipment on a tax-free basis. The act now limits like-kind exchanges to real property that is not held primarily for sale.
Limitation on Business Interest Expense Deduction
Many large and medium-sized farming operations are heavily reliant on credit financing. The act carves out an exception to the new deduction limitation for business interest expense for farming businesses and businesses engaged in the trade or business of specified agricultural or horticultural cooperatives. Therefore, farmers will continue to be able to deduct business interest expense.
Prior law allowed for a deduction for interest paid or accrued by a business in the computation of taxable income. The act limits the deduction for net interest expenses incurred by a business to the sum of business interest income, 30% of the business’s adjusted taxable income, and floor plan financing interest. The act exempts businesses with average annual gross receipts of $25 million or less from the limit. At the taxpayer’s election, any farming business as well as any business engaged in the trade or business of a specified agricultural or horticultural cooperative is not treated as trades or businesses for purposes of the limitation, and therefore the limitation does not apply.
Recovery Period for Farming Property
In prior years, farm assets were limited to 150% double declining balance. Now 200% double declining balance is allowed on specific assets.
Decreasing the recovery period for farm property and allowing farmers to use the double-declining balance method of depreciation for farming property will benefit the farming industry.
Under prior law, any property (other than nonresidential real property, residential rental property, and trees or vines bearing fruits or nuts) used in a farming business was subject to the 150% declining balance method. Additionally, property used in a farming business was assigned various recovery periods in the same manner as other business property. For example, depreciable assets used in agriculture activities that were assigned a recovery period of seven years included machinery and equipment, grain bins, and fences (but no other land improvements) that were used in the production of crops or plants, vines, and trees; livestock; the operation of farm dairies, nurseries, greenhouses, sod farms, mushrooms cellars, cranberry bogs, apiaries, and fur farms; and the performance of agriculture, animal husbandry, and horticultural services.
The provision shortens the recovery period from seven to five years for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business, the original use of which commences with the taxpayer and is placed in service after December 31, 2017.
The provision also repeals the required use of the 150% declining balance method for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property). The 150% declining balance method will continue to apply to any 15-year or 20-year property used in the farming business to which the straight- line method does not apply, or to property for which the taxpayer elects the use of the 150% declining balance method.
Temporary 100% Expensing for Certain Business Assets
Increasing the amount that is eligible for immediate expensing will help all businesses, including the farming industry.
Under prior law, taxpayers were generally not permitted to expense the full cost of acquiring property for business use the year they purchased it. Instead they had to take depreciation deductions allocated over the “useful life” of the property. For certain property, taxpayers were permitted additional first-year depreciation of 50% of the adjusted basis of the property the year it was placed in service, if placed in service before January 1, 2020. If the property was manufactured or produced by the taxpayer, the manufacture or production must have begun before January 1, 2020.
The act allows taxpayers to immediately expense 100% of the cost of qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. The act further proposes to incrementally phase down the expensing though 2026 – taxpayers will only be able to immediately expense 20% of the cost of qualified property acquired and placed in service after December 31, 2026. The incremental phase down is one year longer for property with longer production periods. The act also expands the property that is eligible for this additional depreciation to include “used” property. Taxpayers will be allowed to elect 50% expensing in lieu of 100% expensing for qualified property placed in service during the first tax year ending after September 27, 2017.
Section 179 Expensing
The immediate expensing of assets will provide a benefit to all businesses including the farming industry.
Prior law permitted businesses to elect to expense up to $500,000, subject to phase-out if the costs exceeded $2 million (both indexed for inflation).
The act increases the expensing limitation and the phase-out amount, and expands the types of property subject to the election. The act allows businesses to expense up to $1 million subject to a phase-out of if the costs exceed $2.5 million (both indexed for inflation).
The act also permits the expensing of improvements to roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
Modifications to the Estate, Gift, and Generation-Skipping Transfer Taxes
The Tax Policy Center estimated in 2017 that only 80 small farms and closely held businesses — estates with farm and business assets totaling no more than $5 million and making up at least half of the gross estate — would not pay any estate tax that year. While very few farming businesses are subject to the estate tax, raising the exemption amounts, even temporarily, should make even fewer farming businesses subject to the estate tax.
The 2017 tax act doubles the exemption amounts (as adjusted for inflation) from prior law amounts of $5 million for individuals (as adjusted for inflation, $5.49 million in 2017) and $10 million for married couples using portability (as adjusted for inflation, $10.98 million in 2017).
The act does not repeal any of the transfer taxes and sunsets the exemption increase effective in 2026, meaning the exemption will return to prior law levels (with inflation adjustments through the interim period) absent further action by Congress. The bill directs the IRS and Treasury Department to draft regulations to deal with the sunset to ensure that there is no double taxation of gifts.
Repeal of the Deduction for Domestic Production Activities
The act repeals the deduction for domestic production activities for all taxpayers for tax years beginning after December 31, 2017. This repeal will have a negative impact on many farming businesses.
The deduction applied to proceeds from agricultural products that were manufactured, produced, or grown by farmers. It was equal to 9% of the lesser of taxable income from qualified production activities (including but not limited to manufacturing) or 9% of taxable income. The deduction was further limited to 50% of the W-2 wages paid by the taxpayer.
It was estimated by the National Council of Farmer Cooperatives that the deduction for domestic production activities returned nearly $2 billion annually to rural areas.
Please contact us at 816-858-5959 or services@ungercpas.com to discuss the new rules that are impacting your farming operation. It is important that we meet before year end to create and implement tax planning steps to help you maximize opportunities created by the tax reforms.