Disclaimers and Caveats
First, the standard disclaimer. This is not meant to be tax advice. If you think you might be able to use any part of any of these ideas, consult with your tax professional.
Second, a caveat. No business decision should be made based entirely on tax savings. If it does not make good, stand alone, sense without the tax savings, don’t do it.
Third, another caveat. At the time this is being written (Feb 2013) the uS economy is in a long and deep depression. Uncertainty is the primary reason recovery is stalled. Business people are reluctant to invest in new product lines or hire new workers because they have no idea as to what kind of shenanigan the Federal Government and/or its enabler the Federal Reserve Bank is going to pull next. All I can guarantee is that this is the current information at the time of writing.
Although it is very intimidating, the tax law is subject to a great deal of “interpretation.” To illustrate: I worked in a CPA firm (for three miserable years in another life) when one of the partners retired and bought a farm. The following year, the non-retired partner commented on his former partner’s tax return. “When he was with the firm, he wanted to ‘capitalize’ waste baskets. Now that he is farming, he wants to ‘expense’ farm tractors.”
When it comes down to a matter of interpretation, ask yourself, “could I defend this in tax court?” If so, take the benefit of the doubt. The worst that could happen is that you get audited, the deduction is denied, you give them (at the point of a gun) more money and go on your way. Which brings up another warning.
US tax law is, to my knowledge, the only body of law in any civilized society where the person has to prove their innocence. The auditor says you owe me more, then you owe him more unless you can prove that you don’t. (Is this a great country or what?) But to this point it is a civil matter, meaning no jail time is involved.
But, when fraud is involved (intentional tax evasion verses avoidance), then it becomes a criminal matter and your ass can go to jail. But, at least at that point, the burden of proof reverts to the government.
With all of that out of the way, I have always objected to the term “loophole” when used in reference to the tax law. To me, that connotates something that was left there by accident. I assure you, it was no accident.
The very rich pay little to no taxes because they 1) wrote the laws, and/or 2) can afford expensive tax attorneys to help them with the “loopholes.” So, they rely on the rest of us to foot the bill by convincing us that we are paying our “fair share.” They also know that we can’t afford fancy tax lawyers and they rely on us being either too lazy or too stupid to read and interpret the tax law for ourselves. But the law is the law and it can work just as well for the average Smith as it does for the average Kennedy. Let’s see how it might work for a land rich-cash strapped rancher.
Internal Revenue Code (IRC), Section 179 Election to Expense Certain Depreciable Business Assets
According to my Commerce Clearing House 2013 Master Tax Gide: Code Section 179 provides “an expense deduction to taxpayers who elect to treat the cost of qualifying property as an expense rather than a capital expenditure.” In cowboy English that means that, instead of having to put the property on your depreciation schedule and write it down over a number of years, you can deduct the whole amount in the year you purchase the property.
Qualifying Section 179 Property: So exactly what kind of property qualifies as Section 179 property? Well this gets a little government gobbledygooky but hang with me. Back to the Master Tax Guide. “To qualify as Section 179 property, the property must be tangible (and depreciable) Section 1245 property (new or used) and acquired by purchase for use in the active conduct of a trade or business.” Have you got the feeling we are being ran-around in circles?
So what is Section 1245 Property? Back to the old Gide we find that Section 1245 property is depreciable personal property. (Note: In business law all property is either real property [land and permanent attachments thereto] or personal property [anything that is not real property]). Are we beginning to realize that all this was written by a bunch of damned lawyers? Dig in.
Some, but not all, livestock are considered Section 1245 property. Breeding animals (mother cows and bulls) are depreciable and therefore they fit the definition of Section 1245 property. However, stocker cattle and/or your calf crop are considered “inventory for resale” and are not depreciable and therefore are not considered section 1245 property.
(Note: Although it is beyond the scope of this short article, be aware that depreciation taken on livestock and certain other assets is subject to “recapture” rules. That means that if you sell the asset at a gain and before the specified “holding period,” a portion of that gain will be “recaptured” and taxed as ordinary income instead of at the capital gain rate. This could be a trap. Consult your tax advisor.)
In addition to breeding livestock, “single purpose agricultural structures” are section 1245 property. In my judgment (we are back to interpretation) any number of things found around the ranch fit that definition– feeders, waterers, portable lambing sheds, etc. all have a single purpose, all are used in a trade or business, all are depreciable and all personal (not real) property.
How about grazing cells? Well, to the extent that the center is attached to the land, it becomes real property and is therefore not section 1245 property. But, many of the things associated with the cell would qualify. How about the portable livestock scale or the portable loading chute or portable Powder River panels or the portable electric radial fencing? I would think that all of those things would qualify. I’m sure you can think of more. But again, consult your tax advisor.
Dollar Limitation: I mentioned uncertainty above. That is well illustrated by the way the limitation to the amount that can be deducted under Section 179 has fluctuated wildly over the past several years. For tax years beginning in 2008 and 2009, the deduction was $250,000 per taxpayer. For years beginning in 2010 and 2011, it increased to $500,000 per taxpayer. For 2012 it fell to $139,000.
And here is the bad or good (uncertain) news. Absent further legislation, for tax years beginning in 2013 and thereafter, the limitation is only $25,000. Let us hope (and lobby) that the congress critters will come to their senses and provide a real economic “stimulus” by allowing individuals to keep what rightfully belongs to them. History bears it out. Drastic reductions in taxes generally result in drastic increases in tax revenue collected–economic logic tells us that is because the tax reduction stimulated the economy.
Let’s look at what you could have done if you had your business organized into two corporations (a land company and a cattle company) which would be two separate taxpayers. In 2008 and 2009 you would have had to make $500,000 before paying a dime’s worth of income tax. In 2010 and 2011 it would have had to be a smooth million. In 2012 it would have taken $278,000 in profit to trip your income tax trigger.
And even if the criminals at Foggy Bottom on the Potomac fail to act, you can buy one hell of a lot of slick electric wire for $50,000.
There is at least one more “loophole” for ranchers that should be at least mentioned.
Under another Section of the IRC, Soil and Water Conservation Expenditures are generally deductable but there is one very large catch.
Although there is no dollar limitation, “deductions are limited to those that are consistent with a conservation plan approved by the Soil Conservation Service of the USDA or, in the absence of a federally approved plan, a soil conservation plan of a comparable state agency.”
For a cattle rancher, my recommendation would be, don’t do it.
First of all, contracting with the government in such a manner transfers a property right to that government that almost always ends up with a bad outcome.
And second, most of these plans will involve expensive, heavy handed, energy consumptive, agronomic methods like mechanical or chemical brush control and re-seeding. Hardly any of these ever so much as pay for themselves much less provide a return on investment.
You, your finances, your land and your livestock will all be much better off spending after tax dollars on more fencing and more cattle.
Final thought: If there is anybody out there who thinks that forfeiting your hard earned property at the point of a gun and the threat of being locked in a steel cage is just really a great idea, you would be more than welcome to pay my “fair share.”
Source: Commerce Clearing House, 2013 Master Tax Guide.
Dr Jimmy T (Gunny) LaBaume [send him mail] is President and CEO of Land & Livestock International, Inc.
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