We’ve been hearing a lot lately from ag producers who are interested in land improvements depreciation. The tax rules that allow the depreciation and expense write-offs of the amounts you spend on land improvements also come with some interesting twists in logic. We’ll explore those today.
When talking about tax depreciation, we first have to make note that the definition of “land improvements” does not include buildings, grain storage facilities or single-purpose agricultural structures. Those assets have different depreciation rules and lives. What the definition does include is things like land leveling and land clearing, reservoirs and irrigation ditches, dams, pavement and other things that improve a raw piece of land’s capabilities.
The amounts you spend on land improvements are separated into four potential tax classifications:
- Repair expense
- Depreciation expense
- Soil and water conservation expense
- Non-deductible increase to the cost basis of land
If an expenditure doesn’t fall into one of the first three categories, then it’s going to count as an increase in the cost basis of your land and won’t be deductible until you sell the land.
Since we’re talking about land improvements depreciation, let’s dive into the first three categories:
1. Repair expense
Repair expenses include what you spend to repair or maintain an improvement that already exists. If you removed sediment from a drainage ditch or reservoir, that counts as a repair expense.
2. Depreciation expense
Depreciation expenses include what you spend on assets that you expect to use for more than one year, but which won’t have an unlimited useful life — aka, the asset will deteriorate over time. These assets are usually man-made and include things like pavement, drainage tile, water and sewage lines, water wells and cattle guards.
Most of these assets have a tax depreciation life of 15 years. They qualify for bonus depreciation but not the section 179 expense election (although we should note that most components of a livestock or irrigation well or a drainage system do qualify for section 179).
Fences and corrals used for agriculture have a seven-year deprecation life and are treated like equipment for depreciation expense purposes. Also note that earthen structures can be depreciated if you can prove that the improvement you made to them will deteriorate over time.
3. Soil and water conservation expenses
Speaking of all things earthen, in many cases, earthen improvements to the land that will not deteriorate over time will be treated as a capital investment and added to the cost basis of your land. However, farmers have the opportunity to deduct these expenses as soil and water conservation expenses. Qualifying improvements include things like leveling land, removing trees and brush, planting windbreaks, terracing or furrowing, and building earthen dams, ditches, diversion channels and ponds.
Below are some important points to be aware of:
- In order to be deductible, the expenses need to be either 1) part of a plan approved by the Natural Resources Conservation Service (NRCS) or 2) consistent with NRCS requirements or those of a state plan.
- The deduction is limited to 25% of your gross income from farming. However, the excess deduction can be carried forward to the next year.
- Any amounts you spend on your conservation project that are eligible for the depreciation expense category must be depreciated and therefore cannot be included as a soil and water conservation expense.
- Land clearing expenses that prepare land for farming are not eligible unless it’s the conversion of grazing land to farm land.
To claim the expense, you simply report it on the appropriate farm schedule line of your tax return. Any amounts you do not elect get added to the cost basis of the land.
Most tax advisors interpret the election to be an accounting method, meaning it’s binding on all future years unless you follow procedures to change the accounting method. The expenses also must be recaptured as ordinary income if your land is sold within 10 years of you making the expenditure. However, the recapture is reduced if the sale happens between five and 10 years of the expenditure.
Have you made recent land improvements?
Tax rules can be very detailed and complex, but the tax system provides benefits for those who understand them and how they can be leveraged. We encourage you to discuss your land improvements depreciation options with your tax advisor to see how the rules affect you and what benefits you can reap.
Learn more about other tax-related topics, like deductions, by exploring our Ag Conversations blog. You can also read more here:
Farm Tax Deductions and Other Changes: 2018 Tax Season Observations
The New Depreciation Expense Rules – What You Need to Know