Farmers and ranchers are planners. There are plans for planting and harvesting, crop rotation and herd migration, equipment maintenance and purchases, retirement and succession, estate and taxes, and so much more. All industries pose unique tax planning and savings challenges, and this is especially true for farming and ranching. The mention of tax planning tends to bring federal income taxes to mind, but farmers and ranchers should also consider strategies that save at the state and local levels (e.g., real estate tax, sales tax, and in Texas, franchise tax).
There are numerous ways for farmers and ranchers to reduce or postpone federal taxes. As with any other business, the ordinary and necessary costs of operating a farm for profit are deductible business expenses. Most farmers and ranchers use the cash method to report their net income meaning, cash received from the sale of their product is included income in the year received, and cash spent to purchase items used by the farm or ranch is deductible in the year either paid or purchased via a loan (e.g., credit card or note payable).
We know that when we purchase a new car, the moment we drive it off the lot, it decreases, or “depreciates” in value. Depreciation is the write-off of the cost of capitalized property and equipment used by a business over a specified period.
Bonus depreciation currently allows taxpayers to write-off 100% of the purchase price of equipment and certain farm buildings in the year acquired, while the land is not depreciable. When a taxpayer purchases property, it’s important to identify the value of the various underlying assets acquired and segregate those costs from the land to maximize deductions.
Taxpayers should be mindful of Hobby Rules and operate with a profit motive and not primarily for sport, recreation or tax write-offs. If the operation produces a profit in at least 3 out of the last 5 years, the IRS will presume they have a profit motive.
Unique for landowners is Easement or Right-of-Way income, which gives someone else access to your land for a specified purpose (e.g., for laying pipelines, constructing electric or telephone lines, or giving access to neighboring land). These payments may not be taxable upon receipt. Instead, the payments reduce the basis in the allocable land, which, in turn, postpones the recognition of income until the taxpayer sells the land or payments exceed the taxpayer’s basis. Capital gain rates can apply when payments become taxable as long as the agreement is considered permanent. Payments limited by time, however, are considered rental income and taxed at ordinary rates when received.
Tax treatment for damage payments varies depending on the cause of the damage, so careful planning should take place when negotiating an agreement. Damage payments for crop or profit loss and anticipated surface damages are generally taxed at ordinary rates. Payments for damage to land are treated the same way as easements.
REAL ESTATE TAX
In Texas, farmers and ranchers can save on their real estate taxes by obtaining what is commonly known as an “ag exemption,” which values land at its ag value instead of fair market value (FMV). As with any real estate exemption in Texas, you must qualify and apply. To qualify, the land must be “currently devoted principally to agricultural use to the degree of intensity generally accepted in the area for five of the seven years preceding the application.” When applying, consult your local comp-troller on the “agricultural use” and “degree of intensity” tests given that every county is different. Failure to meet the degree of intensity test while still meeting the agricultural use test results in a steeper FMV tax assessment going forward. Failure to meet either test results in rollback taxes, which can be substantial as it equals the difference between taxes assessed based on FMV and ag value for the 3 preceding years.
Farmers and ranchers can also save on sales tax because Texas provides an exemption when supplies, machinery, and equipment are used exclusively on a farm or ranch to produce agricultural products for sale. The state provides an extensive list of items that are exempt versus taxable. To qualify, taxpayers must apply for and have a current ag/timber number. Take note of the word “exclusively” just mentioned. A road to the “back 40” may not be tax-exempt if it also provides access to a residence since it would contain a personal use component. With careful planning, track-ing costs separately for the mixed-use and exclusive use portion of the road can result in substantial tax savings.
Farms and ranches operated in Texas may be subject to franchise tax if held by any type of entity other than most “general partnerships” or certain grantor trusts and estates. Few owe tax, especially since the “no tax is due” threshold is a substantial amount; $1,180,000 or less for 2019. However, in recent years, with the increased exploration of oil and gas throughout the state, many farmers and ranchers with mineral rights have increasingly found themselves paying this tax. If this applies to you, there are ways to structure and separate ownership of the minerals from the farm/ranch operation and reduce the tax. However, we recommend consulting a skilled attorney and CPA if planning to do so.
Successful farmers and ranchers plan well. At ADKF, we can help you with your business, estate, and tax planning to contribute to your future success.READ MORE