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Year-end depreciation strategies
You have at least four options for setting up depreciation claims before December 31, 2013. Next year, depending on politics influencing the continuation of bonus depreciation and Section 179 accelerated depreciation provisions, the options could be different.
The greater influence on depreciation decisions will be farm income levels. Tax brackets at 35% – or maybe even the new 39.6% rate – of net income are likely to be faced by more farmers than ever before, says Larry Gearhardt, Ohio State University farm tax specialist.
As such, it’s to your advantage to get net income below the 35% threshold if your income this past year puts you in that bracket. The next lowest tax rates are 28% and 15%. “Suppose that you’re bumped up into a 35% rate. How can you reduce that (net income) to lower your tax burden to a more reasonable level? That’s going to be the most critical factor at the end of the year regarding your income,” Gearhardt says. “How can you utilize a depreciation strategy?”
Gearhardt teaches tax advisers to try to get clients to plan ahead up to five years.
Don’t buy iron just to avoid taxes
One thing you can do is to manage the timing of inputs you purchase, advises Kevin Dhuyvetter, Kansas State University Extension specialist. “You can prepurchase seed and fertilizer for next year. Likewise, you can purchase machinery to manage taxes. It is important not to purchase machinery strictly for tax avoidance. Purchasing machinery you don’t really need might lower your tax liability this year, but it could actually increase future machinery costs.”
Both Gearhardt and Dhuyvetter urge that December is the time to review the options and make the choice. If you do want to shelter more 2013 income, you may want to make a big-ticket purchase on or before New Year’s Eve. The depreciation amount applies in full for the tax year that’s ending. The purchase can be machinery, but it also could be a new farm building or land improvement with drainage tile.
Gearhardt and Dhuyvetter suggest you not just go down a list of options (see “5 Depreciation Options”). Rather, take a long-term view or strategy. A five-year strategy is ideal.
However, nothing guarantees that bonus depreciation and Section 179 accelerated depreciation will be available for 2014. Those provisions expire on December 31 unless Congress extends them again.
“If you don’t have that available in 2014 and after, there is more pressure to use it this year and not just throw away those benefits,” Gearhardt says. “Farmers are going to need to pay very, very close attention to tax reform discussions this month as to whether or not we get these benefits in the future.”
Another consideration is that selling equipment too soon after a Section 179 claim can bump up the net income (and the tax bracket) in another year if money received from the sale of machinery is more than the depreciated value.
In that sense, the worst thing to do is to completely write off a big-ticket purchase from 2013 income and then have a farm dispersal sale for retirement (perhaps unplanned) in 2015 or 2016. Probably, Gearhardt warns, a few folks will hit that wall. They will have a year without farm income and will have a bill to pay back $100,000 in recaptured depreciation.
“That’s why this thing is so critical, and each operation is different,” Gearhardt says. “Each operator is unique. These are valuable tools to use when, and if, you need them.”
Bear in mind what happened in the 1970s
Remember the collapse of the agricultural economic bubble around 1980 and remember that history tends to repeat itself.
In those days, like today, commodity prices were good, land values were rising quickly, and an investment tax credit gave an incentive to stretch the bubble a bit further. People went out on a limb on good advice.
Suddenly, the farm economy collapsed.
“Remember that. I think that’s why farmers now carry less debt than the general public. Things could change very quickly. Farmers see it and want to remain very conservative in their investing,” Gearhardt says.
The depreciation tools today are extremely important for some individuals, but they also seem to be on the sidelines for most farms. “I don’t think they’re being used by very many people. In my opinion, farmers are planning for the future by not taking advantage of the Section 179 deduction,” Gearhardt says.
Capitalize on depreciation option
Dhuyvetter thinks Gearhardt may be right in that not all producers readily use these options. However, they can be beneficial as you try to manage your tax liabilities.
He sees the fast-acting options – rapid depreciation and bonus depreciation – as being tools that give you some flexibility with the tax load.
“It’s not a way of reducing or eliminating tax liability; it’s a way of deferring it to another year when you have less taxable income,” Dhuyvetter says. “Rapid depreciation says you can write off all (or a large portion) of the investment in year one. You might want to do this, if this year’s income is above what you expect, as this is a way to take on some extra expense this year.
“However, if you write off the whole amount, that helps reduce the taxable income this year. It’s worth zero on the books for next year,” Dhuyvetter warns. By using the rapid depreciation, you are somewhat trying to outguess your future income.
“On the other hand, you could write off a portion (of investments) immediately to bring your income down to the lower tax bracket and keep the balance on the books. Next year, you can start depreciating that remaining amount in a more orderly fashion.”
The limit for Section 179 rapid depreciation has been changing. It stands at $500,000 per item, with an investment cap of $2,000,000 for 2013 purchases, but it may be different or even cancelled completely for 2014.
The bonus depreciation is up to 50% of the cost of the asset and is limited to the purchase of new assets. Anything beyond that limit has to be depreciated in a normal fashion.
Tax reform effects
Could it end on December 31? “There’s talk about trying to do fairly major tax reform. If Section 179 and bonus depreciation are eliminated, there’s no question it would take away some of the flexibility people have in managing variable income,” Dhuyvetter says.
“These are good tools when income is very hard to predict,” he says. “Volatility is classic with agriculture; so these tools help you try to manage that. If they are taken away, it would not be good, but it probably would not be disastrous.”
5 Depreciation Options
Buy nothing, sell nothing, depreciate nothing, and just take the full tax hit.
Buy a building or big-ticket machine, and put it on the regular depreciation schedule.
Buy equipment, put it on a regular depreciation schedule, and claim the bonus depreciation option.
Buy equipment and use all three depreciation deductions. The Section 179 deduction may be large enough, alone, to write off the whole purchase from the 2013 net income. It could drop the tax bracket from 35% down to 15% or less.
Buy a big-ticket item and claim enough fast-acting depreciation to get below the 35% threshold. Place the rest of the purchase cost on a regular depreciation schedule.
Editor's Note: John Dietz is a freelance contributor for Successful Farming magazine.