This year, farmers have more alternatives to consider with respect to cost recovery or depreciation on assets that they placed in service during 2008.
“Congress wanted to stimulate the economy, so they made two changes that apply to 2008,” says George Patrick, Purdue University tax law specialist. “Both essentially give you more of your purchase price back in the year that it was placed in service.”
First, Congress added a 50% additional first-year depreciation, which allows a farmer to deduct 50% of the costs of new qualifying personal tangible property against 2008 income. That includes equipment and machinery, breeding or dairy livestock, general-purpose farm buildings and machine sheds/shops.
For example, if a farmer trades in a sprayer for a new sprayer, both the tax basis of the old sprayer that was traded in, as well as the additional cash that’s paid, qualify for the 50% additional first-year depreciation. One of the limitations is it’s an all-or-nothing situation. If a farmer bought a new planter and a new sprayer, both in the seven-year property class, that person has to take the 50% additional first-year depreciation on both, or neither, of them.
Congress also increased the Section 179 expensing limit from $125,000 to $250,000 for 2008. Patrick says Section 179 expensing can apply to both new or used tangible personal property in the 15-year property class or less. That includes dairy and breeding livestock, machinery and equipment, land improvements such as tile drainage, and single-purpose farm buildings.
According to Patrick, Section 179 expensing provides farmers more flexibility, unlike the all or nothing 50% additional first-year depreciation. The amount elected could range from $1 to whatever the cost of the asset was, as long as the total isn’t more than $250,000. It’s important to be aware that not all tangible personal property is eligible for Section 179 expenses, such as general-purpose buildings. Single-purpose buildings – buildings that have one intended purpose and can’t be used for something else – are eligible.
If neither of these tools will suit, it may be worth looking at farm-income averaging, Patrick says. It’s a tool that essentially takes the unused tax brackets from the previous three years (2005, 2006 and 2007) and taxes part or all of the farm income for 2008 based on the prior three years’ rates. Patrick says this tool won’t work for all farmers, but has the potential to save a person quite a bit in taxes.
Before they can determine which of these strategies to use, farmers should look at what their receipts and expenses are and where they are in terms of taxable income and make the necessary adjustments, Patrick says. Expenses include things like depreciation and interest – items deductable for tax purposes.
“It’s important to have some kind of income level you’re trying to hit annually, rather than swinging up and down dramatically each year,” Patrick says. “This has been such a crazy year and farmers may not be in the position they expected to be in, but there’s still time between now and Dec. 31 to make changes.”
If income is lower than expected, look at selling commodities and postponing additional purchases until next year, he explains. If income is higher than expected, consider prepaying expenses and putting off additional sales, or at least arrange it as a deferred payment, until 2009.
After making necessary changes by the end of the year, producers then can work with a tax professional to determine which strategies will work best, he says. When working with a tax professional, it’s important to be organized, because they bill on an hourly basis.
It’s also important to work with a tax professional for more than one year. This will give the tax person a chance to better understand the business, and the producer a chance to learn what the tax professional needs and wants.
Patrick cautions farmers not to get so wrapped up in trying to reduce the amount of tax they owe, but to focus on the basic economics of it. He also notes that the highest marginal income tax rate is 35%, which means farmers will pay at least 65% of the cost of a tax-deductible expense.
-- Purdue University release