From depreciation to deductions: What farmers and ranchers should know about the new tax law

You can lower your taxes by deducting most anything you purchase instead of capitalizing it over several years

The Tax Jobs and Cuts Act of 2017, signed into law last December, is the largest overhaul of the United States tax code in 30 years.

Many of the key changes made by the legislation will have a positive impact on individuals and businesses. In broadest terms, the new law delivers tax cuts to middle-income families and makes American businesses more competitive.

What are some of the key changes for farms and ranches?

Section 179 depreciation increases. Under the old law, the Section 179 expense was limited to $500,000. The expense deduction phased out when total eligible property acquired exceeded $2 million (with indexing for inflation). With the new law, farmers will be allowed to immediately write off capital purchases. That includes breeding livestock, farm equipment and single-purpose structures such as grain bins, up to $1 million. The phase-out on this expensing provision kicks in when a farm reaches $2.5 million in purchases.

Bonus depreciation rises to 100 percent. With the old law, a first-year bonus depreciation deduction was allowed, equal to 50 percent of the adjusted basis of qualified property whose original use had begun with the taxpayer. The new law allows farmers to write off 100 percent of qualified property. It also expands to include new and used property, whether purchased or constructed, and to fruit- and nut-bearing plants and trees.

Keep in mind that many states don’t conform exactly to the federal bonus and 179 depreciation provisions. In most cases, depreciation taken at the state level is different. For example, a farmer expensing 100 percent of a capital purchase with bonus depreciation may not receive that same dollar amount deduction at the state level.

• Farm equipment depreciation continues. Machinery and equipment (other than any grain bin, fence or other land improvement structure) will be able to be depreciated over five years, as long as the original use of the asset begins with the taxpayer. The old law depreciated those assets over seven years.

An immediate tax drop—and a note of caution

What does all this mean? The good news is that you can lower your taxes by essentially deducting most anything you purchase instead of capitalizing it over several years. So, immediately your taxes will be even lower. Congress uses this tactic not really to lower your taxes but to spur economic growth and usually it works.

What is the down side? Be cautious that you don’t put yourself in a cash-flow bind later. This issue can happen when you expense a large purchase but end up paying for the asset over time on a loan. Here’s a case in point: If cash flow gets tighter in a future year, and you have to sell more crops to make payments, and you don’t have much current-year depreciation, you can end up owing tax in a year when you don’t have much excess cash to pay it with. Principal payments on loans are not deductible.

So, make sure you know your projected cash flows to make the payments. Don’t get spend-happy just to save taxes. You can also get in a double-whammy situation when machinery values decline faster than you are paying your loan. This means you can’t sell the machinery and have enough money to pay the tax and your debt.

Like-kind exchanges cease for livestock and equipment

A Section 1031 exchange, also known as a tax-deferred exchange, is a common, straightforward strategy used by farms and ranches. Previously, you could trade in machinery on a purchase and defer paying tax on any gain on that traded piece until after you sold the new equipment. The downside previously, though, was that you could only depreciate the ‘boot” or the difference you paid on the trade.

With the new law, Section 1031 exchanges continue for buildings and land but end for livestock and equipment. For example, farmers can still swap land for other land tax-free, but equipment trade-ins will no longer be tax-free events. This makes equipment trading more of a thoughtful tax and cash-flow event. While you could pay tax on a traded asset, just you like you sold the equipment, you will now be able to deduct the full purchase price of the acquired property.

Additionally, the traded (or sold) asset may be taxed differently than the acquired asset as far as depreciation and self-employed tax are concerned. So, going forward, you will definitely want to discuss your strategy with your tax preparer before making any trades.

Section 199 deduction changes

I have been in a lot of discussions on this tax change. Basically, Section 199, also known as the Domestic Production Activities Deduction, was repealed and replaced. Agricultural and horticultural cooperatives will have a new 20 percent deduction. However, unlike the DPAD, this is taken at the cooperative levels and isn’t directly passed on to patrons. The big news is that non-corporate taxpayers will also get a 20 percent deduction to offset ordinary income.

There are limitations associated with this 20 percent deduction, such as the amount of wages you pay.  The deduction only offsets income tax, not self-employment tax. So, what this means to you is it may pay for you to sell your commodities to a cooperative and claim the 20 percent deduction on those sales. This provision will likely change as this was an unintended consequence and also has several important considerations on how things are calculated.

The bottom line? Just don’t immediately change what you are doing without doing some tax reform analysis with an expert.

Estate-tax exemption doubles

The new legislation doubles the exemption amount for estate, gift and generation-skipping taxes. The old base, set in 2011, was $5 million. Under the tax overhaul, the new base is $10 million, good for tax years 2018 through 2025. The exemption is indexed for inflation, so an individual could have $11.2 million in assets without owing federal estate tax.

Another federal estate law provision called portability lets couples who do proper planning double that exemption. So, a couple could exclude $22.4 million for 2018. This will be a tremendous planning tool for farms and ranches who often have land that may be worth a lot but have very little cash. Use caution here though, as this law sunsets in 2025 and the exemption amount would revert to the indexed $5 million base.

Also, the tax bill doesn’t change the rules regarding the step-up basis at death. That means that when you die, your heirs’ basis in the assets are reset at current market value.

Dennis Roddy is a Midwest-based agricultural consultant with K·Coe Isom. With more than two decades of experience in ag lending and farm management, as well as real-world farming and ranching experience, he is uniquely qualified to help farmers and ranchers operate profitably. Contact him at [email protected].