We had a reader ask the following question:

“Hi, I just inherited a Kansas wheat farm with an oil well on it. I assume that I still get the 15% percentage depletion on the oil royalty. My question is do you know if I can “value” the oil and then take a larger cost depletion deduction from the royalty income? ”

Many farmers in the Midwest and other areas of the United States may have situations similar to this reader.  Many of our clients are now making more money from their oil and gas income than from farming. 

One method of reducing this income is the use of depletion.  Cost depletion is similar to depreciation and is based upon the amount of units sold during the year compared to the estimated total units still available to be sold.  For example, assume a farmer inherits a piece of farm land with an oil well on it.  A qualified survey of the oil well is performed and it is estimated there is 30,000 barrels of oil still to be pumped from the ground.  During 2011, the farmer pumps 1,000 barrels of oil.  The value of the oil in the ground at the time of the inheritance was estimated at $300,000 or $10 per barrel, therefore, the cost depletion deduction for 2011 is $10,000 (1,000 barrels times $10).

Another method of depletion is the use of percentage depletion.  This method takes the gross income derived from oil sales and times it by a percentage (in most cases 15%).  The farmer is allowed to use either percentage or cost depletion each year and is entitled to the greater of each.  This can be cost one year and percentage the next.  In our same example, lets assume the farmer collects $50,000 from the sale of their oil for the year.  Percentage depletion based upon 15% would equal a deduction of $7,500.  Since cost depletion of $10,000 is higher than percentage depletion, the farmer would deduct cost depletion in this year.  However, lets assume the farmer received $100,000 from the sale of their oil.  In this case, percentage depletion of $15,000 would be higher than cost depletion and the farmer could use percentage depletion.

One drawback of depletion is that the farmer must reduce the basis in their oil and gas property by the amount of depletion taken. 

As you can see, these calculations can get complicated and there are various other rules on percentage depletion that can limit the amount of this deduction.  If you have an oil and gas well on your farmland, you should review this with a tax advisor that understands this type of taxation.

But, the bottom line is you can take cost depletion based on the cost allocated to the oil reserves if cost depletion is greater than percentage depletion.

As most everybody knows, I spent most of last week on the Midwest Crop Tour.  The weather this year was much better than last year when we got rained on for one full day of the tour.  I do not remember even getting one sprinkle this year.  My thoughts are as follows:

• Last year, I remember having multiple stops where the corn yield was over 200 bushels.  Also, I remember that at least 70% or more of the corn yields were 170 or higher.  This year, each day, we would only have one or two fields over 200 and perhaps 3 other fields in the 170 range.  All of the other fields were less than 150 each day.  However, last year, our lowest yields were substantially lower than this year.  We never had a yield under 100 bushels this year and last year, I remember having several under 100, primarily in South Dakota and North Central Nebraska.  This year, we did not cover any of that area.
• The soybeans on average looked very good this year, however, the heat and lack of rain may be getting to them.  If the beans get a couple of inches of rain in the next couple of weeks, they should yield fairly well.
• At all four of the evening stops, the farmers in attendance were not a bullish about their yields as last year.  At the same time last year, all of the crops looked very good, however, the finish to the crop was poor.  This year, most farmers expect a poor finish, but hope for better.
• There were more people on this year’s tour and more of them were not farmers.  It appears that the tour is one of the best guides for industry groups such as traders, hedge funds, farm media groups, etc. to get a good handle on where the crop is headed.
• Pro Farmer does an excellent job of putting on the tour.  From Chip and Brian leading each leg to the other staff involved in making each day and night run smoothly, I just want to reinforce how good of a job they do.

All in all, this year’s Midwest crop tour shows a lower crop than last year or the three year trend and I look forward to next year to see how it turns out.

Since I had a meeting in Austin, Minnesota today at 3 pm, I had to miss taking corn and bean counts for the day.  After taking counts yesterday for almost 12 hours straight, I actually did not mind the rest.

Also, during yesterday’s route, I ended up cutting two of my fingers with a corn stalk leaf and to use a farm term, bled like a “stuck hog”.  The other scout in the corn field did not do well with the sight of human blood, so I was running out of the field dripping blood all the way.  We got it cleaned and bandaged and since I seem to get a tetanus shoot every five years or so (I have way too many scars on my body to keep track of), I am fairly sure I will be fine.

Tonight, we had the recap of the corp tour with the meet up of the western and eastern legs of the crop tour in Austin, Minnesota.  A crowd of easily 400 farmers and more than 500 people total found out that the estimated corn crop for both Minnesota and Iowa will be down from last year.  Remember that this is the estimated biological crop.  The actual harvested crop per acre will be down probably even more due to all of the wind, hail, and maturity issues involved with this year’s crop.

The chance of this year’s crop being higher than the August 1 USDA estimate, in my opinion, is somewhere between slim and none.  We shall see.

Tomorrow is a travel day home and I will be posting again next week.

I am sorry I did not post about day three of the crop tour sooner.  I have had multiple issues with cell phone coverage and Internet service on this trip so far.

Yesterday, we had to go north about 25 miles from Nebraska City before taking the toll bridge over the Missouri River near Plattsmouth, Nebraska.  Again, as we crossed the river, we noted multiple buildings, pivots and other structures under multiple feet of water.  That area will still take many weeks or months to recover.

We then headed due south and got almost to the Missouri border and then turned East.  For about 30-40 miles of driving in this area, we saw many areas of hail and wind devastation to the crops.  In one 80 acre field, we saw maybe 3 ears of corn standing with the remainder of the whole crop laying completely on the ground.  I tweeted a couple of these photos to Twitter.

The average bushel count for corn in this district was barely 110 bushels.  As we crossed over I-80, we came upon our largest yield of the date at about 205 bushels, however, the land was very dry and this ended up being one of our worst soybean count.  The corn crop was set a few weeks ago, however, beans are still making pods, etc. and this heat and lack of rain is not helping.

We then traveled almost to the top of Iowa and turned West to get to Spencer, Iowa.  The corn  in this area was very steady in the 160-200 range and it appears that the two west districts in central and northern Iowa may be a little better than last year, however, Southwest Iowa is expected to be 20% or more worse than last year.

I will post you on the last day either tonight or in the morning.

Just finished up with the dinner and presentation on the numbers.  Appears there was almost 200 farmers in attendance.

Nebraska corn was called about 4-5 bushels less than last years crop tour’s numbers but almost exactly equal with the three year trend.  This was in line with my two days of going on the route.  I did not see any bumper crops out there, but also did not see any major disasters.

The big news of the night was the crop in Indiana.  The USDA was calling for 150 bushels on August 1.  The Crop Tour came in with about 143 bushels which is about 19 bushels under the three year trend.  Normally, the Crop Tour numbers need to about about 2-3 bushels to get the actual number for the year.  This means the USDA number may be about 5 bushels too high.

Since both South Dakota, Ohio and Nebraska call for lower numbers, it is up to Iowa and Illinois to make up for the Indiana shortfall.  We will find out on Illinois tomorrow and Iowa on Thursday.

I will keep you posted.

Today was our lightest day of traveling.  We left Grand Island, Nebraska this morning at 7 am and spent most of the day headed a little south, then east, then north, then east, then south and east to finish at Nebraska City, Nebraska at the Lied Lodge at the Arbor Day Farm.  If you have never been to this lodge, I would highly suggest visiting it.

On the route, I would call the counts we had nothing special either way.  We had a couple around 200, a couple around 110, and the rest in the 120 to 175 range.  We visited 10 counties and made a total of 10 counts.  Our average bushel per acre for corn ended up at exactly 150.

In comparing our counts to the county averages for last year, 2 were higher, 1 was even and the other 7 were lower, but you can not tell anything from one route on the tour.  Pro Farmer will issuing their calls for Nebraska and Indiana tonight and I have no way of knowing which way it will go.

Tomorrow, we leave and tour Western Iowa and end up at Spencer, Iowa in the Northwest corner of the state.

I will probably make a post after tonight with my thoughts on the numbers.

We arrived late Sunday night in Sioux Falls, South Dakota just in time for the meeting with all of the other tour participants.  With the flooding of the Missouri River near Omaha, we had to make several detours which probably added an hour to our drive.  The river looks like it has come down maybe a foot, but it is still very high.

We left Sioux Falls around 6:30 Monday morning and made a direct bee line to Sioux City, Iowa and crossed over the Missouri River there.  We took a sample in Dakota County which was in the 135 range and then moved into Dixon where we saw extensive hail damage from the storm of last Thursday.  Talking to some folks at the local convenience store, we noted that the storm took out a swath of about 5 miles by 100 miles and I know we saw about 25 square miles of this.  You would look at a bean field and all you saw was some light green stalks with no leaves or pods on them as far as you could see in the field.

We then motored another 30 miles or so west and then turned south for about 15 miles and then came back due east for about 40 miles.  In each County, we took a least one sample.  In about the fourth County, we got our first irrigated field sample and that ended up the best of the day at 230 bushels.

Bean samples were generally in the good range, however, there were several areas that we noted were extremely dry and if they do not get rain, the beans are in trouble.

We noted many areas where the stalks had been knocked over due to either wind or hail or both and all scouts noted hail damage in many of the fields.

Throwing out the high irrigated sample, our yield estimates ranged from a low of 102 to about 175 and compared to last year, our yields were down.  However, it appears that the call for South Dakota and Ohio is very much in line with the USDA estimates and tomorrow we will be finished with Nebraska and will have a better idea where we are at.

I tried to post during the drive, however, the cell service in Nebraska on our route was spotty at best and I could not get enough service to get my IPad to post to the site, so I will have to write a nightly recap of the trip.

However, I am tweating to Twitter (say that fast five times in a row) throughout the day at @farmcpa, so please follow me there.

I am spending the night in Spokane since my plane leaves at 6:30 tomorrow morning. I did not feel like getting up at 2 am to drive three hours to catch my flight. That is one of the joys to living in Yakima, Washington.

I will arrive in Kansas City tomorrow at about 1 and meet up with my farm partner and then make the five hour drive to Sioux Falls, SD to meet up with the Western leg of the crop tour group. Looks like there will be about 40 of us in the West and about 60 on the East leg.

I think with the very wet spring in the East nobody really knows how well that crop is doing. By the end of the week we should have a better idea.

I plan on writing two or three posts each day and I am writing this on Blogsy on my IPad and so far it seems to be going good.

I will keep you posted.

The IRS publishes each month the Applicable Federal Rates (AFR).  They just published the rates for September in Revenue Ruling 2011-20.  These rates are broken down into three different terms:

• Short-term (less than 3 years)
• Mid-term (more than 3 and less than 9 years)
• Long-term (more than 9 years)

These rates determine the minimum interest rate that must be charged on loans.  If the interest rate charged is less than these amounts, then the tax laws require us to “impute” interest based upon difference between the required AFR and the actual interest rate charged in the note.

For example, assume the AFR for a five year loan is 5% and the loan charges no interest.  If the balance on the loan for the current year if $100,000, then $5,000 of the payment would be considered interest and the remainder principal.

As most readers know, interest rates are nearing all time lows (at least for my lifetime) and the current AFR for short-term loans is .26%.  That is correct 1/4 of one percent.  On long-term loans, the required AFR is slightly more than 3.50%.

Therefore, any loans between family members should try to use these interest rates so you would not have to impute interest.

I expect to even see these rates go slightly lower next month and the month thereafter.

There was an interesting article in the Wall Street Journal this morning about how the USDA issued information regarding the current wheat harvest that normally would required a Freedom of Information Act request to get.

Previous reports from the USDA had pegged the spring wheat crop at about 12.7 million acres.  The report just released reduced this acreage report down to 11.7 million acres.  As a direct result, the price of spring wheat has gone from a low of about $8 this month to slightly more than $9.

The 12.7 million number was reported as part of the National Agricultural Statistics Services (NASS) and the 11.7  million number came from the Farm Service Agency (FSA) which is constantly getting updates from farmers that are not always incorporated into the NASS system.

The primary cause for the decrease in acres relates to the more than 2.6 million acres that did not get planted in the northern U.S. Plains.  The excess rain and flooding in these areas prevented many farmers from planting any crops.

Hopefully, this release of data without a formal Freedom of Information Act request will lead to this data being reported more timely in the future.