By Ann Braun & Steve Powers

The tax law known as the Tax Cuts and Jobs Act (TCJA) made significant changes in tax depreciation benefits for farming equipment. These include opportunities available under Section 179 and bonus depreciation, which can bring cost saving opportunities to farmers and ranchers who purchase machinery and equipment. Other changes, particularly the new limit on business interest expense deductions and the new 20 percent deduction against qualified business income (QBI), may affect acquisition and depreciation planning.

Bonus depreciation

Under the TCJA, farmers can take a 100-percent bonus depreciation deduction for capitalized purchases of equipment placed in service after Sept. 27, 2017 and before Jan. 1, 2023 that have a depreciable life of 20 years or less. Prior to the TCJA, the bonus depreciation rate was set to be 40 percent for 2018 and 30 percent for 2019.

A majority of farming property (whether new or used) qualifies for 100 percent bonus depreciation, including agricultural and horticultural structures, farm buildings and trucks. Thanks to another change in the TCJA, farming equipment can now be depreciated over five years, revised from seven years, for tax years beginning after Dec. 31, 2017. The five-year depreciation life excludes grain bins, fences or any land improvement structures. To qualify, the use of the equipment must initiate with the taxpayer.

Section 179 expensing

A farmer can choose to expense the cost of any qualifying tangible property under Section 179 in order to deduct it in the year the property is placed in service. The TCJA increased the maximum deduction from $500,000 to $1 million, and the phase-out threshold was raised from $2 million to $2.5 million. For taxable years beginning after 2018, these amounts will be adjusted for inflation. The TCJA also expanded the list of eligible tangible property to include roofs, HVACs, fire protection and alarm systems and security systems. Farms that have significant purchases of property ineligible for bonus depreciation, such as building improvement property, should consider Section 179 expensing as an alternative.

Interest deduction limitation

The TCJA imposed a new limit on the amount of business interest expense a business can deduct under Section 163(j). Deductions are limited to interest income plus 30 percent of a business’s adjusted taxable income (ATI). Until 2022, ATI is calculated with addbacks for depreciation and amortization, roughly equating a familiar {span}earnings before interest, tax, depreciation and amortization (EBITDA) calculation. This new limitation, however, is set to become more onerous after 2021, when the ATI number loses the depreciation and amortization addback. Unused business interest expense can be carried forward indefinitely.

There are certain exceptions to the business interest limitation. Farms with average annual gross receipts not exceeding $25 million for the prior three taxable years that are not “tax shelters” are exempt from the limit. Farmers and ranchers can also choose to elect out of the limitation on business interest, and make their business interest expense fully deductible. There is a trade-off for this election: the electing farming business must depreciate all assets with a recovery period of 10 years or more—including trees, wells, farm buildings, and below ground irrigation—using the slower ADS rules. More importantly, bonus depreciation would not be available for these assets.

Qualified business income deduction

The TCJA provides a 20 percent deduction against qualified business income (QBI) to owners of businesses other than C corporations. The 20 percent QBI deduction is limited to the greater of:

• 50 percent of the business W-2 wages; or

• 25 percent of the business W-2 wages plus 2.5 percent of the unadjusted basis of qualified property.

Farming businesses that are structured as partnerships, S corporations, or sole proprietorships can maximize the QBI benefit by making purchases of tangible property to increase the qualified property basis. The unadjusted basis of qualified property is the acquisition cost of all capitalized depreciable tangible property. Such property is qualified property for the duration of the depreciable property life, or for 10 years if the depreciable life is less than 10 years.

Weighing your depreciation options

The increased bonus depreciation opportunity clearly benefits and incentivizes farmers to invest in new equipment or reinvest in existing property, but the business interest limitation necessitates a detailed evaluation of the benefit trade-off for assets with a recovery period of 10 years or more.

The business interest limitation effectively reduces the tax benefit subsidy provided to highly leveraged businesses in the agriculture industry. Further, if equipment is highly leveraged, the looming change for depreciation addbacks after 2021 will worsen this result. The ripple effects of disallowed interest may affect mandatory tax distributions for partnerships and loan coverage ratios negotiated under prior law.

Farmers must now evaluate the present value of bonus depreciation deductions and the potential benefits of the QBI deduction against any potential disallowed interest deduction. Conversely, they must calculate the value of deducting all interest paid against using slower depreciation lives and no bonus depreciation for longer lived assets.

Now more than ever, the agriculture industry must rely on comprehensive financial modeling to accurately assess these tax trade-offs. Strategies to mitigate or resolve these issues exist and require experienced analysis. Your tax advisor can help to assess the unique effect of these tax law changes on your farming business so that you can make the most effective purchasing decisions.

Ann Braun is a Managing Director in the Bakersfield office of CBIZ and MHM, one of the nation’s top ten accounting providers. She is experienced with tax consulting and tax return preparation, as well as succession planning and estate planning in the agriculture industry. She can be reached at abraun@cbiz.com

Steve Powers is a Manager in the Bakersfield office. He specializes in tax planning and consulting for the agriculture industry. He can be reached at steven.powers@cbiz.com.

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