This week, Smuckers, the makers of Folgers and Dunkin Donuts retail coffee announced an 11% increase in the cost of their coffee.  This comes on top of a 10% increase in February, a 9% increase in August of last year and a 4% increase in May of last year. 

If you apply all of the increases announced by Smuckers, the wholesale cost of coffee has increased by slightly more than 38% from May of last year.  This price increase is what Smuckers charges to the retail stores that sell the coffee.  The actual price increase to consumers may be slightly more or less than this, but we know coffee prices are dramatically higher than last year.

There is some speculation that commodity investors and speculators have caused most of the increase, however, as previously mentioned in this blog regarding other commodity increases, the world is rapidly reaching the point where food demand is outpacing food supply and if this keeps up, we will continue to have rapid price increases like in coffee.

Many of our readers will ask us questions about starting a farm, however, when discussing it with them, many of them are talking about a hobby farm and not a real farm.  For tax purposes, a hobby farm has some very unfavorable consequences to the farmer.  Net income is always reported, however, a net loss is limited in zero.

Therefore, how do you make sure that your farm is a farm and not a hobby.  Here are several items to keep in mind:

• Your intent of the farming operation is to make money, not create a tax loss.
• You must run the farm like a regular business.  This means having a separate checking account for the business; do not commingle personal funds and farm funds together; have letterhead and business cards for the farm, etc.
• If the operation runs at a loss for several years, you must be able to document how the farm will finally make money.  In some cases, showing how you have created extra value in the farm when it will be sold will be sufficient, but be ready for an audit if the farm shows too many years of losses.
• A horse farm has a greater chance of being determined as a hobby farm.
• The size of the operation can affect the hobby status.  It is fairly hard to argue that a 2 acre garden plot is a farm (however, in some extensive forms of farming, this can be true).

Remember, the key point to ask yourself, is this truly a operation operated like a farm business, or is it merely intended to create a tax loss.  If it is the latter, then it is more difficult to not treat as a hobby.

The Thursday edition of the Wall Street Journal had a front page article on how the rapid increase in wheat prices is contributing to the turmoil in the Mideast.  Most of the Mideast countries consume a much higher percentage of wheat in their diet than any other countries in the world.  For example, Americans consume about 177 pounds of wheat on an annual basis.  People in Tunisia consume over 478 pounds and Algeria is just behind it at 464 pounds.

Most of this wheat consumption is heavily subsidised by each country’s government, so when the price is high and they are unable to keep the subsidy in place, the people get restless.

Another interesting fact is that Egypt spends almost 7% of its total annual budget on wheat imports alone.  This percentage is what the USA spends on the whole Iraq and Afghanistan war on an annual basis.

Therefore, as American farmers we need to understand how it might be nice to have high wheat prices here, but it may cause other issues around the world.

In a post a couple of days ago, I indicated that a new Ag building placed in service after September 8, 2010 but where the construction started before that date would not qualify for 100% bonus depreciation, but would qualify for 50% bonus depreciation.

There is one exception to this rule that may help farmers some.  Any unique component that can be separately determined to have commenced construction after September 8, 2010 and placed in service before the end of this year may qualify for the 100% bonus depreciation.  A unique component is any material part of the construction that can be identifiable by both the start of construction and its costs.

For example, if a farmer constructs a machine shed that starts before September 9, 2010, this building can only be depreciated using 50% bonus depreciation.  However, if the machine shop has an unique door system that is started after September 8, 2010, then this door can be deprecated using 100% bonus depreciation.  Another example of a component that may qualify is a feed handling system or watering system installed in a hog barn.

The farmer must elect on the tax return to use this method of depreciation on these components, so it is very important to review this with your tax advisor during construction and when preparing your tax return.

With the turmoil in the world commodity markets and the concern about the flooding and weather conditions in the US, farmers can expect that their commodity prices are going to whipsaw up and down very rapidly over the next several months.  A key to not getting personally whipsawed is to have a written plan in place for when you plan on selling your crop.  This written plan should have very detailed triggers for what causes the sell decision.

Too many farmers verbally tell their neighbor they will sell the crop at $5 and it never quite hits this price.  Many farms are now approaching $5 million in sales or higher and this requires a more detailed disciplined approach to selling their crop.  Also, using market professionals to help sell your crop is worth a consideration.

What is your plan and is it in writing.

The tax law passes late last year had a very favorable tax treatment for the construction of new farm buildings.  In that law for any new farm buildings placed in service after September 8, 2010 and before January 1, 2012, a farmer would be able to write off 100% of this new construction cost in the year placed in service.

For example, if a farmer started to build a new machine shop in late 2010 and placed it in service in May, 2011, they could deduct 100% of this cost on the 2011 tax return.  Most tax advisors were under the assumption that this 100% bonus depreciation would apply on any new building placed in service between these dates.

However, the IRS has thrown us a curve ball in that their intrepatation is that both the contruction must commence and be placed in service during these time periods.  Therefore, if in the above case, the farmer started the construction before September 9, 2010, then they can only deduct 50% of the new building as bonus depreciation.  The beginning of construction is defined “as when physical work of a significant nature begins”.

If this applies to your operation and you deducted 100% of the new building on your 2010 tax return, you will need to review with your tax advisor to see if an amended tax return is required.

Just a personal note to let you know that a friend and I are riding our motorcycles to Los Angeles from Yakima for my second’s son college education.  Two down and two to go.

I will be gone from today until next Tuesday and may not do any postings between now and then.

During 2008, grain markets were almost as high as they are now, however, many farmers were not able to take advantage of these prices either through already having their crop sold or through inaction by the farmers.

I don’t know how many times I have heard a farmer in my office or out in the field tell me “I will sell my crop when it reaches $5 a bushel (or some other round number).  As you can guess, it usually reaches $4.95 and then turns around and drops to $3 a bushel where the farmer will then sell the crop to pay for next year’s inputs.

Make sure this does not happen to you.  Right now any grain crop farmer should be able to lock in profits for this year, probably next year and maybe even the year after.  Make sure to review your cash flow projections and if you have not locked in any profits, at least consider locking in all of your input costs.  If you still want to participate in any upward major moves, you can purchase call options on your crop.  There are several services that can help you with this.

Try not to be the $5 / $3 farmer this season.