FACT SHEET Agriculture and Natural Resources

 
FACT SHEET
                                      Agriculture and Natural Resources
                                                                                                               OAM-1-12

Depreciation of Farm Drainage Tile
                                           Wm. Bruce Clevenger
                                OSU Extension Educator and Assistant Professor

Introduction
   Agriculture is one of Ohio’s largest industries. Be-        uselessness. Depreciation is a farm business expense
cause much of the state is characterized by fertile, flat      deducted on a taxpayer’s federal tax return.
soils and adequate rainfall, crop production occurs
on 45 percent of Ohio’s land area. About 55 percent            Economic vs. Tax Depreciation
of Ohio’s agricultural soils need drainage improve-                Economic depreciation relates to the asset’s de-
ment to minimize soil erosion, excess soil-water               clining ability to produce revenue as the asset wears
conditions in the plant root zone, and unfavorable             out and ages. Farm managers need to plan for asset
field conditions for farm equipment in the spring              repairs and eventual replacement. Tax depreciation
and fall. Improved drainage has been found to reduce           is the allowable business expense for IRS purposes. It
water runoff, peak outflow rates, and sediment losses          may or may not be close to the economic depreciation.
while increasing crop production yields. This increase         Farm drainage tile that has a zero or salvage value for
in productivity increases the value of the land and            tax depreciation may be efficient and productive on
land rents, but comes at a cost. It frequently will cost       the farm if having been properly installed and well
$600–$800 per acre to install systematic subsurface            maintained.
drainage tile, but this expense can be written off over
time as depreciation.                                          Eligibility Issues
                                                                  To be eligible for depreciation, property must meet
Depreciation                                                   all of the following requirements.
   The term depreciation is used in accounting to              • It must be property you own.
spread the cost of an asset over the span of the as-           • It must be used in your business or income-pro-
set’s expected life. Depreciation reduces the value of            ducing activity.
the asset over time due to its use, wear and tear, or          • It must have a determinable useful life.

                                       Copyright © 2012, The Ohio State University
Depreciation of Farm Drainage Tile—page 2

• It must have a useful life that extends substantially        tion 1245 Property) upon the sale of the asset prior
  beyond the year you place it in service.                     to the expiration of the recovery period.

How is the Depreciation Figured?                               Determining Basis
   To figure your depreciation, you determine (a) the             A (e) basis amount is the beginning or adjusted
depreciation system, (b) property class, (c) recovery          value used to calculate the annual dollar amount
period, (d) depreciation method, (e) basis amount,             deducted as a depreciation expense for each asset
(f) placed-in-service date, and (g) convention.                item. Any IRS Section 179 expense deduction and/or
                                                               bonus depreciation is subtracted from the basis, and
Depreciation System, Property Class, Recovery                  the remaining balance is then depreciated.
Period, and Depreciation Method                                   When multiple assets are purchased or inherited
   Farm drainage tile is depreciated under the                 in one transaction, the new owner must allocate the
(a) Modified Accelerated Cost Recovery System                  purchase price or estate value among the assets to
(MACRS) and (b) is classified as tangible property             establish the basis in each of the assets. If the buyer
with a (c) recovery period of 15 years when using              and seller agree on an allocation based on the value
the General Depreciation System (GDS). MACRS                   of each asset and the buyer and seller have adverse
provides three (d) depreciation methods under the              interests, the IRS will generally accept the allocation.
GDS and one method under the Alternative Depre-                IRC 1060 may require taxpayers to report the alloca-
ciation System (ADS). However, the recovery period             tion on Form 8594 if the assets constitute a trade or
for drainage facilities (tile) are determined as follows.      business or if there is “goodwill or going concern”
• GDS: 15 years                                                value attached to other assets. Regardless, the basis
• ADS: 20 years                                                is allocated among the tangible assets in accordance
   For drainage tile, this means the choice of (d)             with fair market values.
depreciation methods are as follows.
• GDS using 150% Declining Balance                                New Drainage Systems
• GDS using Straight Line (15 years)                                 Fair market values for basis are easily determined
• ADS using Straight Line (20 years)                              if the landowner is adding a new farm drainage
   If you are using the declining balance method,                 system. The basis becomes the cost of the material
you switch to the straight line method in the year                and the labor for installation minus any allowable
it provides an equal or greater deduction than the                Section 179 expense deduction and/or “bonus”
declining balance.                                                depreciation.
   Farm drainage tile qualifies as IRS Section 179                Previously Installed Drainage Systems
property expensing if the owner meets the require-                   Fair market values for basis of previously in-
ments. Section 179 allows for the recovery of all or              stalled drainage systems must consider several
part of the cost of certain qualifying property up to             factors. The first is to ascertain how much tile
a limit, by deducting the expense in the year the as-             is installed on the land in question. Tile maps,
set was placed in service. For 2012, the Section 179              acquired from the previous landowner or the
limit is $139,000 (inflation adjusted) and a phase-out            drainage contractor, are the best source of infor-
threshold of $560,000. For 2013, unless Congress                  mation. These maps should contain the location
amends the statute, the limit drops to $25,000. If re-            and size for laterals, mains, and control drainage
quirements are met, farm drainage tile may qualify for            structures. Another good source of information are
Section 179 property expensing, regular depreciation,             depreciation schedules, maintained since installa-
and “bonus” depreciation when available by the IRS.               tion, about the cost and amount of tile installed.
Depreciation, Section 179 property expensing, and                 Furthermore, aerial photographs taken following
“bonus” depreciation are subject to recapture (Sec-               a heavy rain early in the year when vegetation is

                                       Copyright © 2012, The Ohio State University
Depreciation of Farm Drainage Tile—page 3

  sparse or non-existent often reveal the location                Mid-Month Convention
  of mains and laterals. Aerial photographs may be                  Use this convention for nonresidential real
  available from local soil and water conservation                property and residential rental property.
  district offices or from free online computer soft-
                                                                  Mid-Quarter Convention
  ware (i.e., Google Earth). Once the amount and
                                                                     Use this convention if the mid-month conven-
  size is determined, replacement cost is often used
                                                                  tion does not apply and the total depreciable bases
  as the starting point to determine fair market value
                                                                  of MACRS property you placed in service during
  of the drainage tile system. The replacement cost
                                                                  the last 3 months of the tax year are more than
  is typically discounted to reflect the age, size, and
                                                                  40% of the total depreciable bases of all MACRS
  material of the tile as well as the condition of the
                                                                  property you placed in service during the entire
  tile field. The fair market value calculated may not
                                                                  year. Under this convention, you treat all property
  coincide with the remaining basis of the previous
                                                                  placed in service or disposed of during any quarter
  owner’s depreciation schedule. In the absence of
                                                                  of the tax year as placed in service or disposed of at
  evidence, the IRS suggests two options. One, check
                                                                  the midpoint of the quarter . This means that 1.5
  the property tax statements for the ratio between
                                                                  months of depreciation is allowed for the quarter
  the land and the improvements. If the statement
                                                                  the property is placed in service or disposed of.
  shows that land is 40% of total property value, then
  you know that 40% is not depreciable. Or two, the               Half-Year Convention
  tile should approximate five percent of the cost of                Use this convention if neither the mid-month
  the unimproved land. This percentage method is                  convention nor the mid-quarter convention ap-
  rough and does not reflect the age, condition, size,            plies. Under this convention, you treat all property
  or type of the farm drainage tile.                              placed in service or disposed of during a tax year
      In rare cases, such as comparable sales located             as placed in service or disposed of at the midpoint
  in the area where comparable land can be found                  of the year. This means that one-half year of de-
  with and without tile lines, the taxpayer may be                preciation is allowed for the year the property is
  able to show the value of the farm drainage tile by             placed in service or disposed of.
  showing the difference in the market value of land
  that does not have tile.                                     “Bonus” Depreciation
                                                                  Over the past decade, Congress has repeatedly al-
Placed-In-Service Date and Convention                          lowed faster depreciation of capital assets to stimulate
   You begin to depreciate your property when you (f)          business investment by providing a Special Deprecia-
place it in service for use in your trade or business or       tion Allowance or “bonus” depreciation allowance
for the production of income. You stop depreciating            in the year the asset is purchased. The Tax Relief,
property either when you have fully recovered your             Unemployment Insurance Reauthorization, and Job
cost or other basis or when you retire it from service,        Creation Act of 2010 extended the depreciation bo-
whichever happens first. Under MACRS, (g) averag-              nus for 2011 and 2012 to encourage new equipment
ing conventions establish when the recovery period             purchasing. The additional first-year depreciation
begins and ends. The convention you use determines             rules allowed farmers to deduct on their 2011 income
the number of months for which you can claim de-               tax returns 100 percent of the cost of qualifying as-
preciation in the year you place property in service           sets purchased in 2011 and 50 percent of the cost of
and in the year you dispose of the property. Use one           qualifying assets in 2012.
of the following conventions.
• Mid-Month Convention                                         Farm Drainage Tile Depreciation Example
• Mid-Quarter Convention                                          Assume that a crop-share rental landlord installs
• Half-Year Convention                                         farm drainage tile costing $50,000 on his property

                                       Copyright © 2012, The Ohio State University
Depreciation of Farm Drainage Tile—page 4

in July 2012. Assuming he meets the other require-                    tion, and regular depreciation must be recaptured
ments of Section 179 Expense Deduction and uses                       to the extent it exceeds straight line depreciation
the GDS 150 percent declining balance method, his                     upon sale of the property. The calculated recapture
depreciation record could look like the following for                 amount must be reported as income for the year
the first 5 years.                                                    the asset was sold.
                                                                   4. Does the installation of farm drainage tile come
 Original Basis      $50,000
                                                                      under the Soil and Water Conservation Expense
 Section 179         $12,000
                                                                      limits of 25 percent of gross income from farming?
 50% Bonus           $19,000              ($50,000 -
 (2012)                                   $12,000 x .50)              Answer: No, assets that are depreciable are not
                                                                      eligible for deduction as Soil and Water Conserva-
 Remaining Basis $19,000
                                                                      tion Expense.
 2012                $950                 ($19,000 x 5.0%*)        5. If the farm drainage tile installed has dual purposes
 depreciation                                                         (drainage and subsurface irrigation), are the depre-
 2013                $1,805               ($19,000 x 9.5%*)           ciation rules changed?
 depreciation                                                         Answer: No, it appears that the underground pipes
 2014                $1,625               ($19,000 x                  and wells would qualify as Section 1245 property
 depreciation                             8.55%*)                     used as an integral part of production and therefore
 2015                $1,463               ($19,000 x 7.7%*)           be 15-year MACRS property eligible for Section
 depreciation                                                         179. Pumps and portable sprinklers are tangible
 2016                $1,317               ($19,000 x                  personal property. They qualify as Section 1245
 depreciation                             6.93%*)                     property, are eligible for Section 179, and have a
 *Percentage tables are available in IRS Publication 946,             7-year class life.
 How to Depreciate Property.
   Total depreciation for 2012 for this farm drainage              Summary
tile could be $31,950 ($12,000 + $19,000 + $950).                     Landowners install farm drainage tile because do-
                                                                   ing so helps remove excess soil water, improve soil
Common Questions and Answers                                       productivity, and reduce erosion. Farm drainage tile
                                                                   has a positive benefit-cost ratio ranging from 1.3 to
1. Do tile expenditures qualify for Section 179 Expense
                                                                   3.1 for corn and soybean across various tillage and
   Deduction?
                                                                   crop rotation systems. When properly installed and
  Answer: Maybe. The person paying for the tile                    maintained in combination with improved surface
  has to be in a trade or business, be “meaningfully               drainage, it reduces year-to-year variability plus in-
  participating” according to earned income rules,                 creases yields. However, the cost of installing, major
  and meet Section 179 requirements.                               improvements, or original basis may be written off
2. Do I separate the cost of material from installation            as depreciation in an IRS-approved method.
   costs?
                                                                   References
  Answer: No, the total cost of installing the farm                Brown, L. C., B. M. Schmitz, M. T. Batte, C. Eppley,
  drainage system is considered the depreciable basis.               G. O. Schwab, R. C. Reeder, and D. J. Eckert.
  Labor costs for installing the tile is a part of the total.        “Historic Drainage, Tillage, Crop Rotation, and
3. Do I have recapture of depreciation as ordinary                   Yield Studies on Clay Soils in Ohio.” pp. 456-464
   income if I sell the farm before the end of the de-               in Drainage in the 21st Century: Food Production
   preciation (recovery) period?                                     and Environment. Proc. 7th International Drain-
  Answer: Yes, farm drainage tile falls in Section                   age Symposium. Brown, L. C., ed. Vol. 7:02-98. St.
  1245 property. So expensing, special deprecia-                     Joseph, MI: ASAE, 1998.

                                           Copyright © 2012, The Ohio State University
Depreciation of Farm Drainage Tile—page 5

Fleming, Robert D. Farm Income Tax Management:                        McEowen, Roger. Farmland Acquisition-Allocation of
  Depreciation of Field Drainage Tile. Ohio State                       Value to Depreciable Items. Iowa State University,
  University Extension, 2002.                                           Center for Agricultural Law and Taxation, February
Harl, Neil E. “Depreciating Farm Drainage Tile.” Ag-                    2011. http://www.calt.iastate.edu/briefs/CALT%20
  ricultural Law Digest 23, no. 2 (January 20, 2012).                   Legal%20Brief%20-%20DEPRECIATION%20
Internal Revenue Service. Publication 225, Farmer’s                     OF%20DRAINAGE%20TILE.pdf
  Tax Guide. Department of the Treasury, 2011.                        Schwab, G. O., D. D. Fangmeier, W. J. Elliot, and R.K.
Internal Revenue Service. Publication 946, How to                       Frevert. Soil and Water Conservation Engineering.
  Depreciate Property. Department of the Treasury,                      New York: Wiley and Sons, 1993.
  2011.

          Visit Ohio State University Extension’s web site “Ohioline” at: http://ohioline.osu.edu
Ohio State University Extension embraces human diversity and is committed to ensuring that all research and related educational
programs are available to clientele on a nondiscriminatory basis without regard to age, ancestry, color, disability, gender identity or
expression, genetic information, HIV/AIDS status, military status, national origin, race, religion, sex, sexual orientation, or veteran
status. This statement is in accordance with United States Civil Rights Laws and the USDA.
Keith L. Smith, Associate Vice President for Agricultural Administration; Associate Dean, College of Food, Agricultural, and
Environmental Sciences; Director, Ohio State University Extension; and Gist Chair in Extension Education and Leadership.
For Deaf and Hard of Hearing, please contact the College of Food, Agricultural, and Environmental Sciences using your preferred
communication (e-mail, relay services, or video relay services). Phone 1-800-750-0750 between 8 a.m. and 5 p.m. EST Monday
through Friday. Inform the operator to dial 614-292-6891.

                                            Copyright © 2012, The Ohio State University
You can also read
Next slide ... Cancel