Most farmers and ranchers have a decent understanding of tax depreciation. When a business purchases assets, the business entity is allowed to write off the value of the asset purchased over the life of the asset. Land, however, is not depreciable as the value of the dirt & minerals does not decrease over time like the value of structures, barns, fences, etc. When a business purchases a ranch or farm, the value of those existing structures, equipment, and infrastructure can be depreciated for tax purposes. One of the main questions taxpayers ask after a major purchase is “how much can I write off for taxes?” The answer can be very simple – usually, farm buildings are depreciated over 20 years. However, a cost segregation study can accelerate the amount of depreciation taken during the early years of a property investment.
What is a Cost Segregation Study?
A cost segregation study is an analysis of a building, structure, or asset to allocate the purchase price to different categories of useful life for tax depreciation purposes. Allocating a total purchase price into separate asset classes can increase the amount of tax depreciation in the earlier years of an asset’s useful life. Taking advantage of accelerated depreciation and allocation of the purchase price can reduce the effective purchase price of the asset. For Example, let’s suppose a business purchases an office building. The general rule for commercial buildings is that they are depreciated over 39 years. Rather than allocating the purchase price to just the land & the building, the business performs a cost segregation study & realizes they can allocate the purchase price to things such as windows, lighting, HVAC, flooring, roof, landscaping, etc. These categories can have a shorter recovery life for tax purposes than the structure of the building. Similarly, farmers and ranchers can take advantage of a cost segregation study for their farms, land, and infrastructure.
Applicability in Agriculture
Cost segregation studies are extremely common in commercial real estate. However, they are not as common in the farming industry despite their benefits. When purchasing a ranch or farm, taxpayers often allocate the vast majority of the purchase to the land and building(s) purchased. However, the taxpayer stops the allocation at that point and then depreciates the value assigned to the building(s) over 20 years for tax purposes. These taxpayers are missing a major tax savings opportunity by not taking the allocation one step further. Rather than just assigning value to the building (and land), taxpayers should also assign value to land improvements, farm infrastructure, irrigation systems, feeding systems, roads, fences, HVAC systems, etc. While the land is not depreciable, land improvements can be. As we will discuss in the next section, the assigned depreciation periods for these items is shorter than the simple, general assignment of 20 years as previously mentioned. Allocating purchase price (or value) to these shorter period assets increases the amount of depreciation in the early years of the investment.
Agriculture Asset Classes
As mentioned, each asset purchased and owned by a company is depreciated over a different time period. Within the agriculture world, for example, water wells are depreciated over 15 years, farm buildings are depreciated over 20 years, fences are depreciated over 7 years, logging machinery is depreciated over 5 years, etc. Rather than simply taking the purchase price of the property & depreciating that amount over a long term life, a cost segregation study will allocate the purchase price to the individual components with shorter lives to increase depreciation in the early years of the investment.
How to Complete a Cost Segregation Study
Unfortunately, a cost segregation study cannot be accurately completed on your own. There are many quality, competent engineering and accounting firms that can complete a cost segregation study on your behalf. Usually, taxpayers save more in taxes during the first half of an investment to justify the up-front cost of a cost segregation study.
Cost segregation studies can be audited by the IRS. The allocation of the total cost to individual components can be scrutinized by the IRS for its accuracy and reasonableness. Taxpayers considering a cost segregation study should have a discussion with the firm performing the study to understand their audit history, audit assistance that would be provided, and overall risk profile.
Impact of Tax Reform
On December 22, 2017, President Trump signed the Tax Cuts & Jobs Act of 2017 (TCJA). The TCJA, also referred to as the tax reform bill, made significant changes to our individual and corporate tax structure. One of the main areas of reform was to tax depreciation. The TCJA shortened the recovery period for new farming equipment and machinery from seven to five years. Additionally, the TCJA increased the amount of “bonus depreciation” for assets placed in service after 9/27/2017 and allows for certain asset purchases to be fully expensed in the year of purchase. Section 179 of the Internal Revenue Code, by virtue of the TCJA, allows for taxpayers to fully expense certain asset purchases of up to $1 million in the year the asset was placed in service (subject to phase-outs). The expanded depreciation, shorter asset classes, and accelerated depreciation modifications make the allocations in a cost segregation study even more valuable.
Cost segregation studies are common in commercial real estate. However, despite their benefits, many farmers and ranchers do not take advantage of the major tax benefits a proper study can generate. While the overall amount depreciated does not change, a cost segregation study can move more of the depreciation to earlier in the investment and reduce the effective purchase price of a farm or ranch. For further questions, contact your tax advisor or legal representative.
Tyler Davis is a CPA who works for SVN: Saunders Ralston Dantzler real estate as an asset manager. SVN: Saunders Ralston Dantzler is leading agricultural land brokerage based in Lakeland, FL. He also owns his own CPA Firm, Tyler Davis CPA where he provides tax preparation, consulting, and provision services. Tyler can be contacted at firstname.lastname@example.org.