We posted yesterday on the new Senate tax reform proposals and how it might affect farmers. Today’s post will dig even further into the depreciation changes.
First, the positive is that Section 179 has been increased to $1 million from the current $500,000. The proposal also extends the $500,000 limit through 2014 with the new $1 million limit starting in 2015 and then being indexed to inflation in $100,000 increments. This means it would not be adjusted until inflation brings the amount above $1.1 million. In that year, Section 179 would be $1.1 million.
As we discussed, there are now 4 pools of assets. All assets are distributed into these pools and then the net total pool is multiplied by a percentage to arrive at total depreciation for each pool. The Senate seems to believe this would be much easier since you no longer have to account for each asset, however, most farmers have to account for each asset for state income tax purposes, personal property tax purposes and in many cases financial statement purposes. Therefore, I do not believe this to be any improvement.
The pool amount is derived by taking the ending balance from last year, adding all current pool additions, subtracting any sales proceeds. If the sum is a negative, it is reported as a net ordinary gain. If the amount is positive, then an applicable percentage is multiplied. Almost all farm equipment will be placed in pool 2. This pool % is 18%. This is not straight-line depreciation but rather 100% declining balance with no switch to straight-line like current tax law. This means if a farmer invests $1 million in equipment in year one and places it into pool 2 and has no other changes to the pool, it will take 35 years for the asset to be fully depreciated (actually this is the year it drops to less than $1,000 and the law allows you to fully deduct it at that point).
Under current law, this asset would be fully depreciated after 8 years. Under the proposed law, after year 8, about 20% of the asset is still left to be depreciated.
Land improvements such as tiling, irrigation wells, etc. would even take longer to get fully depreciated. Under current law, these assets are fully depreciated after 16 years. They are considered to be 15 year property with a half-year in year 1 and a half-year in year 16. Under the proposed law, over 44% of the asset is still left to be depreciated in year 16 and it takes 135 years to fully deprecate the asset. This is worse than real property be depreciated over 43 years.
Assets falling into pool 3 would take about 55 years to be fully depreciated and this pool includes many assets that would normally be depreciated over no longer than 7 years under current law. Many farmers involved in orchard operations have large controlled atmosphere storage facilities that are currently allowed to be depreciated over 8 years. With the new law, it appears these will be pool 3 assets. This means that after 8 years over 35% of the storage facility is still left to be depreciated and it would take 55 years to fully depreciate it (assuming no other assets in pool 3).
Now for real property. All farm real property is currently depreciated over 20 years except for single purpose ag structures such as a hog confinement buildings which are depreciated over 10 years. The proposed law switches all farm buildings including ag structures to be considered real property depreciated on a straight-line method over 43 years. This is a drastic change for farmers. For farmers owning a house in town that is rented out, this would now stretch the depreciation period from 27.5 to 43 years.
There also appears to be a transitional proceedure for any real property placed in service before 2015. Under this rule, if a farmer puts into service a hog confinement building in 2013 for $2.5 million and takes depreciation totaling $500,000 in 2013 and 2014, his new adjusted basis is $2 million. Under current law, he would be allowed to fully depreciate this by year 11. Under the new law, he would have to take the $2 million and depreciate over 41 years (43 years less the 2 years already taken). This applies to any farm buildings in service before 2015.
In almost all cases, farmers will be much worse off under the proposed depreciation changes. The only case where they are better off is the increased Section 179 limits and the fact they would now be permanent and indexed to inflation.
I do not believe that all of these changes will pass into law, but it is important to note what is being proposed now. If you do not like these proposals, I suggest writing a letter to your Senator(s).
My thanks to Chris Hesse, a Principal in our Minneapolis national office for helping on this post.
Paul Neiffer, CPA