A recent Court Case reminded me that sometimes taxpayers and their advisors can sometimes go too far in trying to create favorable tax situations.  For many years now, taxpayers have taking advantage of using cost segregation studies to allocate part of the construction or purchase cost of buildings to items more closely related to equipment which have shorter lives for depreciation purposes and/or may be available for the Section 179 or bonus depreciation.

For example, if a manufacturer builds a new building that requires extra power to run the machines and special hoses and piping, etc., these costs can usually be depreciated over 15 years or less, rather than the normal 39 years.  However, the taxpayer must have a cost segregation study to prove these amounts.

Now for the Court Case.  In the case, the taxpayer had obtained a cost segregation study on a fairly large apartment complex that they purchased.  This study allocated costs to almost every single component in each building, the sidewalks, the landscaping, the swimming pool, etc.  If the taxpayer had been successful, then all of these components would have been most likely depreciated over 5 or 15 years, not 27.5 years.

However, the taxpayer lost since the Court said all of these components comprise what is normally considered an apartment complex which is depreciated over 27.5 years.  They did allow some items to be depreciated over quicker lives, but not much.

The bottom line for me is if it looks like an apartment complex, then depreciate it like an apartment complex, or the old saying “If it walks and quacks like a duck, then it is most likely a duck”.  These cost segregation studies are a powerful tax planning tool, but they need to be done correctly and in the proper situation.

We just finished a three part series on the top estate planning mistakes farmers make and we had some readers ask which one was most important? This is strictly my opinion, but I think the first one listed “procrastination” is the worst mistake farmers and probably all business owners make. Many farmers will never have to deal with corporations, partnerships, limited liability companies, etc. but all farmers will have to deal with both succession planning and their estate.

The sooner they take direct action, the more likely they will accomplish their goals, not what the government wants for their estate. Just simply taking advantage of the annual gift exclusion available over the last 20 years would allow farm families to give away $2-5 million in today’s dollar value without much work or effort.

Even if your plan is not perfect, it is much easier to correct things alongbthe way than to attempt to fix it at your death. It is up to you, but our advice is “Get Started Now”.

We conclude our series on the top estate planning mistakes farmers make today with:

• Treat all the kids the same – In our seminars on this subject, the question of how to treat farm and non-farm kids can be the most vexing issues for farmers.  Many farmers who control the farm and only pass down the farm upon their death and leave everything equally to all of the kids, while one or more children are actively involved in the farm operation may not be recognizing the extra value that these farm kids have provided.  Generally, we see that the farm operation is split from the farm land rental component and the operation goes to the farm kids and the land is split among all the kids.  Many times, insurance is used to equalize this split also.
• Gift away remainder, keep life estate – Many farmers assume if they keep a life estate and leave the remainder to their heirs, then this asset will not be included in their estate.  WRONG.  This asset is included in your estate, the only thing you avoid is probate.
• Failure to stabilize and maximize values – Does the farm operation maintain key person insurance in case of death or disability.  Are proper buy-sell agreements in place.
• Lack of adequate records – This will drive the trustee/executor crazy!  Have you generated a system to keep track of all of these necessary documents and are they in a safe place such as a safe deposit box.  Have you sat down with your planned trustee or executor and explained where the documents are and what they mean.  The more you do this now, the less expensive and time consuming it will be later on.
• Lack of a master plan for your estate – Many times farmers try to do this plan themselves and get in trouble for it.  As the saying goes “Would a surgeon do surgery on himself?” applies to farm estate planning.  You need to involve the appropriate advisors and try to meet with them at least annually to update the plan.  Conduct an annual “fire drill” to see what the estate and income tax consequences would be.

Failing to plan is planning to fail.  Do not fall into this trap with your estate plan.

Continuing our post from yesterday:

• I am worth less than $5 million, so who cares? – Well, for one thing your spouse might care.  We have a new estate planning opportunity called portability which allows the unused estate exemption to be transferred to the surviving spouse.  So let’s assume you pass away in 2011 worth $3 million.  If you did not file a return, the extra $2 million is permanently lost.  So if you spouse died in 2012 suddenly worth $7 million (especially if you left them everything in a “I love you” will), then they would owe $700,000 of estate tax that they did not need to pay.  Many farmers forget to include life insurance that they own in their calculations.  They might have an estate of $4 million, but $2 million of life insurance.  They think they are only worth $4 million, when they really are worth $6 million.
• Lack of Liquidity – Farmers are great at creating non-liquid net worth (farm land, equipment, etc.), but not as good at creating liquid assets to pay estate taxes.  Do you know how much your estate is going to cost your heirs and where the money is coming from.  Will it negatively impact the farm operation?
• Proper Ownership of Life Insurance – If you own or control the insurance, it is included in your estate.  Have you considered setting up a irrevocable trust to own the insurance.   This gets the proceeds out of your estate and provides liquidity for the estate or income to your spouse for their lifetime.

I got into Nashville late Thursday night/early Friday morning.  Friday morning I headed over to the Gaylord Opryland complex.  Wow, what a facility.  There was probably five acres or more of glass roofing and it felt like a 10 minute walk from my car to the convention center.

I was able to attend the last part of the speech by Secretary of Agriculture Tom Vilsack.  There appeared to be at least 3,000 people in attendance and I think I heard that over 5,000 were signed up for the Classic. 

The Trade Show had more than 100 booths and I was able to walk around most of it on Friday and early Saturday, but I must admit that I did not get to every booth.  It was nice to see several farmers that I had met over the last couple of years and get caught up with what was going on with their farm operation.

Friday afternoon I attended the learning sessions and midway through the third session, I had noticed some noise on top of the ceiling and about 2 minutes later, a guy walked in and told us there was a tornado warning and we needed to evacuate to the basement.  We headed down to the basement and there probably were about 1,000 people in the basement area where I was.  I had downloaded an app to my IPhone and was able to watch the cell pass over our location and get real time weather updates.

After about an hour, the warning was over and we were able to go back to normal, however, by that time, the day was over.

On Saturday, my partner Nick Houle gave a two hour seminar on the Top 10 (there were 11 though) mistakes that farmer’s make in estate planning.  Nick and I had met up the night before and we discussed that attendance might be on the low side since this was the last seminar of the event and many people had already left.  We were wrong.  The attendance ended up being almost SRO (standing room only) and many great questions were asked and I think Nick and I answered them all.

All in all, the Commodity Classic is a great event for any farmer to attend and I look forward to going next year.

Being a farm boy from Washington state, we never had tornados and although the warning was interesting and nobody got hurt in our area, I would be happy never to be part of another one.

Tomorrow I head out from warm and sunny Yakima, Washington (after 4 inches of snow the night before) and travel to Nashville, Tennessee for the Commodity Classic.  I will be walking the trade show on Friday and on Saturday, Nick Houle from our Minneapolis office will be giving a keynote speech on estate planning from 1:30 to 3:30.  I will be helping him with this event and if you are attending this or see me around the show, please stop me and say hi.

Just finished up my last farmer (at least the ones due on March 1) this afternoon and we have less than 50 days of tax season left.

The USDA has reported that there were five corn states in 2011 that generated over $5 billion in corn sales:

1. Iowa – $14.5 billion
2. Illinois – $12.3 billion
3. Nebraska – $9.4 billion
4. Minnesota – $7.0 billion
5. Indiana $5.3 billion

These five states generated 63.4% of all corn sales in the US for 2011.  The states of Ohio, South Dakota and Wisconsin each generated between $3 and $4 billion of corn sales.

For soybeans, the US only had one state over $5 billion and that was Iowa at $5.5 billion with Illinois at $4.95 billion.  The top three corn states generated more in sales than all of the US soybean production of $35.8 billion.

There were only four wheat states that generated over $1 billion in sales:

1. Kansas $2.0 billion
2. North Dakota $1.7 billion
3. Montana $1.3 billion
4. Washington $1.1 billion

Iowa generated more in corn sales at $14.5 billion than the whole US wheat crop of $14.4 billion.

We can see why corn is king in the US based on these statistics.

We posted a couple weeks ago about production for almost all of the major crops in 2011 being down from 2010.  Even though, production was down, income for most of these crops seems to be up in 2011 from 2010.  A recap of the major crops are as follows:

• Corn $76.5 billion up from $64.7 billion (18% increase)
• Soybeans $35.8 billion down from $37.5 billion (4.5% decrease)
• Wheat $14.4 billion up from $12.8 billion (12.5% increase)
• Hay $17.8 billion up from $14.7 billion (21% increase)
• Cotton $7.3 billion unchanged from $7.3 billion
• Potatoes $4.0 billion up from $3.7 billion (8.1% increase)

As you can see, almost all crops yield more sales volume than 2010 with lower production.  This year, my guess is that we might see higher production, yet lower sales.

We will recap some of the income numbers by states during the rest of this week.

We got the following question from one of our readers:

“ I made profits on commodity trades in 2011. The amount was $20,000. The 1099 from MF Global shows $20,000. However, I have received only $14,000 and probably will not get the entire $20,000. How much do I have to pay tax on?; the $14,000 that I received in 2011 or the 1099 showing that I made the entire $20,000?”

This situation is really two separate tax issues.  The first issue is the reporting of the gain on the 2011 commodity trades.  This $20,000 will be reported in 2011 just like any other year.  The taxpayer had gains of $20,000 in the account and they are taxable as realized (we are assuming these are speculative trades; if a hedge, the amounts may be different).

The second issue is whether there is a “theft” loss due to MF Global’s actions.  If it is finally determined that there is a loss and it is considered theft, then it should be fully deductible in 2012, not 2011.  The tax laws indicate that if the amount of the theft loss is not known by the end of the tax year, the loss is not deductible until the amount is known.  In the MF Global case, that will be 2012 at the earliest and could be 2013.

This is a very complex case, but the bottom line is the loss is not deductible in 2011.

It is not too often that we do a post on fruit ag news, but we just recently came across an article in the Good Fruit Grower which is based in my home city of Yakima, Washington.

In the article, a Washington State agricultural economist predicted the apple production in the state for 2021.   For many decades, the largest produced apple in our state was the Red Delicious (Washington is by far the largest producer of apples and for 2012, the total apples sales may be close to $2 billion dollars).  However, this variety is expected to decline from 33 million boxes (42 pounds) to 25 million boxes.

The Gala apple will overtake Red Delicious by about 2018 and be the number one variety in 2021 with a production of about 29 million boxes.  The Fuji variety will be number three at about 21 million boxes.

The big mover, however, will be the Honeycrisp, which appears to be the current favorite apple with consumers.  This variety is expected to jump from the current annual production of about 4 million boxes to well over 13 million boxes in 2021.  I know this apple is probably my favorite one to eat and we have had several plantings of this variety near our house in the last couple of years.

Just to give you some numbers on potential revenue from Honeycrisp based on current all-time prices.  Assume a corn grower is able to get 250 bushels of corn at $7 per bushel.  This is a gross of about $1,750 per acre, which is probably an all time high.  Some Honeycrisp growers may get production in excess of 100 bins per acre, a pack-out of 14 boxes per bin and $35 or more per box.  This equals gross revenue per acre of $49,000 per acre or more in many cases.  Before all the corn farmers start growing Honeycrisp, you need to realize the costs of growing and packing this crop are extremely higher than corn growing.

Total apple production in Washington State is expected to increase from the current 105-110 million boxes to about 115-130 millon boxes by 2021.  Apple growers like most farmers are having better revenue years than in the past, but the future trend of production still appears positive.