2020 is shaping up to be a potentially high-income year for some farmers, especially given the latest round of Coronavirus Food Assistance Program (CFAP) payments.
One tool that will likely come into play for fruit growers this year is the ability to depreciate 100% of the cost of new orchards.
Most farmers are familiar with the uniform capitalization rules. Typically, when orchards are acquired before the trees have reached an income-producing level, the preproductive costs must be capitalized. But a farmer may choose to elect out of the rules at the cost of a slower depreciation method known as the alternative depreciation system (ADS).
Under ADS, depreciation on the trees begins when they reach an income-producing phase that makes commercial sense to harvest.
The good news is that since the PATH Act of 2015, most farming businesses with annual gross receipts of $26 million or less for the three preceding tax years are not subject to the uniform capitalization rules. In other words, those preproductive costs, such as fertilizer and labor, can be immediately expensed.
As mentioned before, even if a grower is not subject to uniform capitalization rules, the trees are not typically depreciable until they become commercially viable.
However, prior to Jan. 1, 2023, fruit growers are eligible to claim 100% special depreciation allowance on the cost of their plantings.
This may be the year that it makes sense to take advantage of this tool. For example, if a farmer planted $500,000 worth of orchards in 2020, the planting can be 100% depreciated. From a multiyear perspective, this tool is available until 2026, although it begins to phase out in 2023 as the chart below indicates.
It is important to remember that many states do not follow the federal rules on special depreciation allowance, so prudent tax planning on your part is crucial.
Let’s look at another example: Let’s assume the costs of high-density orchards are $100,000 in year one. Years one and two have preproductive expenses of $20,000 and $30,000. Below are some of the options available to the farmer:
Option 1. A cash-basis farmer subject to the uniform capitalization rules chooses not to elect out. They also choose to not take advantage of 100% special depreciation allowance on the $100,000 of trees. The $150,000 of expenses would start being utilized in year three, at commercial viability, over a 10-year period.
Option 2. A cash-basis farmer subject to the uniform capitalization rules decides to elect out. They also choose to not take advantage of 100% special depreciation allowance on the trees. The $50,000 of preproductive costs are expensed when incurred.
The plantings, on the other hand, are depreciated over a 20-year period beginning in year three because the fruit grower is now subject to a slower depreciation method known as alternative depreciation system, which depreciates the orchard over a 20-year period.
Option 3. A cash-basis farmer subject to the uniform capitalization rules decides to elect out and to also take advantage of 100% special depreciation allowance. All expenses are deducted when incurred.
Like option 2, the farmer would be subjecting the farm to alternative depreciation system.
Farmers should take a multiyear approach to tax planning this, utilizing tools like special depreciation allowance in a manner that makes sense for the long term.
Arezzo is a senior tax consultant for Farm Credit East.