Farm Law for Operators and Landowners�Tax Concepts for Livestock Owners

Andrew Branan, JD

Assistant Extension Professor

Department of Agriculture and Resource Economics

North Carolina State University

rabrana2@ncsu.edu

New Draft Publication

farmlaw.ces.ncsu.edu

Records Retention �

• Tax laws are enforced by a) denying deductions and b) by random audit
• You place whatever income numbers you wish or classify items as deductible, these are open to challenge up to 3 years after due date (April 15) or extended filing date (October 15). IRC section 6501(a)
• 6 years: 25% under-report of gross income (or excess of $5000) IRC §6501(e)
• Income omissions are discoverable from filings by the taxpayer on the “other side of the transaction”
• No limitation
• Filing a false or fraudulent return - IRC section 6501(c)(1).
• Willfully attempting to evade tax - IRC section 6501(c)(2).
• Failing to file a return - IRC section 6501(c)(3).
• Solution: Scan receipts and store digitally as pdfs on CD or flash drive (minimal space, but make sure keep hardware to read)
• Taxpayer bears the obligation to prove the transaction reporting is correct (no presumption of “correctness”)
• If no record, it did not happen

2021 Tax Rates (need to update)

Who is the Taxpayer?

• Sole Proprietor
• no formal business filing, no separation of business and personal assets
• file under personal SSN
• Partnership
• no formal business filing
• Limited Partnership
• Limited Liability Company
• Corporation
• Estate
• Trust

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See Business Organizations: Partnerships, Corporations, and Limited Liability Companies

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Schedule F v. Schedule C

Schedule F: Farm Income

• Crops
• Livestock, including cattle, swine, goats, sheep
• Dairy
• Poultry
• Honey
• Horticulture
• Cut flowers

Schedule C: Non-Farm Income

• Processed dairy: ice cream, cheese, yogurt
• Processed meat cuts (e.g. jerky, smoked)
• wine, beer and spirits
• Agritourism
• Other: soaps

Classifications of Income

• Ordinary Income subject to Self Employment (SE) Taxes
• Ordinary Income not subject to SE
• Capital Gain

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Ordinary Income Subject to SE

• Income from self-employment
• Farming [Schedule F]
• consulting
• personal services
• distribution from partnership
• K-1 share
• Wages
• from any business
• Tips
• Conservation Reserve Program (if not currently receiving Social Security benefits)

Ordinary Income Not Subject to SE

• Passive Income
• Rent payments
• farm
• cell tower and solar
• Conservation Reserve Program only if current receiving Social Security
• Distribution from limited partnership
• Trust Distributions
• if not providing services to trust
• see TAM-118387-02/CC:PSI:B2

Capital Gain Income

• Tax rate variable, 0%, 15%, 20% depending on income tax bracket
• Rate applied to appreciation (difference between sale price and basis)
• e.g. 15% x ($100,000 - $85,000) = $2,250
• Long term asset sales
• Real Property (land)
• long term assets
• Timber sales
• Stocks held ≥ 1 year
• IRC §1231

Tax Treatment on Sale of Farm Assets

Livestock Sales

• Purchase of raising of livestock for sale in the ordinary course of business treated as ordinary income
• subject to self-employment (SE) tax
• reported on Schedule F
• If livestock held for breeding or draft purposes, then sale is treated as “sale of an asset”
• Section 1231 (not subject to SE)
• sale reported on Form 4797 “Sales of Business Assets”
• Required holding period for cattle = 24 months (otherwise, treated as ordinary income)

Cattle Sale Summary

• Sale of raised breeding animals is reported on IRS Form 4797, Part 1, and generally receives capital gain treatment.
• Basis is zero

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• Sale of purchased breeding animals is reported on IRS Form 4797, Part 3, subject to depreciation recapture and taxed at ordinary income tax rates, not subject to SE tax.
• basis is purchase price

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• Sale of market animals is reported on IRS Schedule F as part of farm product sales and is subject to ordinary income tax and SE tax.

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Farm Asset Depreciation

• Depreciation of qualified purchases over life of asset, amount taken as deduction each year
• MACRS - Modified Accelerated Cost Recovery System
• IRC § 179
• Alternative Depreciation System (ADS)
• allows a longer period of time on asset depreciation
• reduces amount can depreciate in given year
• once elect ADS, cannot switch back
• Bonus Depreciation (new with 2017 Tax and Jobs Act)
• can depreciate full cost (100%) in single year
• must “elect out”

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§179 Depreciation Expense 2017 TCJA

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• Expense deduction over life of property by classification
• New Farm Equipment purchased and placed into service after December 31, 2017 is 5-year MACRS rather than previous 7 years
• Used farm equipment is now eligible at 7-year MACRS
• Grain bins, fences, cotton ginning equipment, and land improvements are 7-year assets.
• 200% declining balance is to be used on 3-, 5-, 7-and 10-year property
• 150% declining balance on 15-and 20-year property

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• The maximum amount one can elect to deduct for most section 179 property placed in service in 2021 is $1,050,000
• reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2,620,000.

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• SUVs are subject to the $26,200 limit in 2021 (eligible for 100% bonus depreciation if they are above 6,000 lbs)

§179 Qualifying Property

To qualify for the I.R.C. § 179 deduction, property must be:

• “qualifying property”
• tangible personal property
• farm equipment, etc.
• “qualified improvement property”
• any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service.
• does not include improvements due to the enlargement of a building, any elevator or escalator, or the internal structural framework of the building
• acquired for use in an “active trade or business”
• acquired by purchase
• not acquired from a “related party”
• from lineal ancestors and lineal descendants (not siblings)

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• Farm Buildings are not 179 property, they are depreciated over 20 year period

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Livestock Depreciation

• Section 179 depreciation schedules
• cattle, goats, and sheep = 5 years
• swine = 3 years
• Depreciation of purchased livestock not held as inventory (i.e. breeding, draft) reduces basis in livestock
• (Raised livestock has zero basis, raising inputs are expensed)

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Bonus Depreciation (I.R.C. §168(K))

• Qualifying property
• tangible with MACRS < 20 years
• including previously leased property
• qualified improvement property (QIP)
• First-year (Bonus) Depreciation
• 100% first-year depreciation (Sept 27, 2017 –Dec 31, 2022)
• Now allowed for new and used property
• After 2022, declining bonus depreciation
• 80% 2023
• 60% 2024
• 40% 2025
• 20% 2026
• Bonus sunsets after December 31,2026
• North Carolina doesn’t conform to Bonus Depreciation

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Qualified Improvement Property

• Improvement to an interior portion of a nonresidential building that is real property
• improvement made after building put in service
• does not include enlargements or work to internal framework
• Ineligible:
• Property placed in service and disposed of in the same year
• Property converted from a business use to a personal use in the year acquired (taxpayers can convert from personal use to business use in the same or later year)

Conservation Expense Deduction

• I.R.C. §175
• Deduct conservation expenses on improvements made pursuant to NRCS or DEQ conservation plan
• Subject to cap: no greater than 25% of total gross farm income
• leveling, grading, terracing
• water diversion and control
• windbreaks and brush clearing (including pasture recovery)
• Endangered Species Act recovery plan
• Enter Line 12 Schedule F

Net Operating Loss Deduction

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– Generally the carry-back provisions are repealed and replaced carry forward with deduction limited to 80% of taxable income.

– For Farmers, the 5-year carry back is modified to 2-year carry-back and then any remaining NOL can be carried forward indefinitely.

– For losses created in tax years beginning after December 31, 2017, the NOL deduction is limited to 80% of taxable income. Carryovers are subject to this limitation too.

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Income Tax Losses – NOL v. Disaster

• Net Operating Loss vs. Disaster Loss
• Tax Cuts and Jobs Act (TCJA) of 2017 eliminated the casualty loss tax deduction as an itemized deduction on personal income tax returns
• For losses created in tax years beginning after December 31, 2017, the NOL deduction is limited to 80% of taxable income. Carryovers are subject to this limitation too.
• Business disaster losses still available
• Sudden or fast moving
• Unexpected and not caused intentionally
• “Unusual”

Disaster Losses – Records

• To prove a deduction for disaster loss, must be able to prove
• That the taxpayer owned the property
• The amount of the basis or book value of the property
• The pre-disaster value of the asset
• The reduction in value caused by the disaster
• The lack or insufficiency of reimbursement to cover the costs

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§1031 Exchanges

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–Generally, for tax years beginning after December 31, 2017, like-kind exchanges are allowed for real property that is not held primarily for sale (inventory)

–Trades of equipment and machinery will be a two-step transaction:

• Sale of traded in item at trade allowance (FMV)

• Purchase of new item (higher basis) can use Section 179 expense or Bonus depreciation to offset tax consequence of sale.

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Timber Sale Basics

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• Timber, for most landowners is a long-term investment receiving capital gain tax treatment
• Should receive an IRS Form 1099-S for the gross amount, to be reported on either IRS Form 4797 or Schedule D.
• Reforestation: $10,000 allowed per unique tract as an adjustment on Schedule 1.
• Anything over $10,000 is amortized over 84 months.

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Estate Tax History

700 BCE —-- Medieval Taxes -------- 1797, 1862, 1916, 1924, 1932, 1948 —---------------------

2001

2002-2003

2010

2009

2004-2005

2011

2012 - 2017

$675,000

$1,500,000

$1,000,000

$2,000,000

$3,500,000

2006-2008

$0

$1,000,000

$5,000,000

TCJA sunset

$5.12M - 5.49M

Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010

Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010

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2000

Tax Cuts and Jobs Act (TCJA)

2018

2019

2020

2021

2022

2023

2025

2024

2026

2027

$11.18M

$11.4M

$11.58M

$11.7M

$12.06M

$5,000,000

[ continued increase ]

Vicesina Hereditatium (Egypt) tax on the 20th penny

Tax Stamp Act (US)

“Dead to the Living”

$650,000

~$60,000

~$50,000

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(= $1,278,500 in 2022)

Current Law: Gifts and Basis

Gift Tax Exclusion Amounts for tax years beginning after December 31, 2017 and before January 1, 2026:

• Annual Exclusion $16,000
• Lifetime Exemption (2022): $12,060,000 ($24,120,000, married couple)
• Carry Over Basis (donee gets same basis as donor)

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Step-up basis to Fair Market Value is retained for death time transfers

• New basis at time of death, reduces capital gains if sold by ‘heirs’
• (see IRC §1014)

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Example Gift: Land purchased in 1985 at $1500/acre, current FMV $8000/ac

• if gift and donee sells, capital gains/acre: ($8000 - $1500 = $6500) x 15% = $985

Example Death Transfer: Same basis, FMV $8500 at date of death

• if death transfer and donee sells, capital gains (with modest appreciation)/acre: ($8700 - 8500 = $200) x 15% = $30/acre capital gain

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Estate Tax Exemption

Estate Exemption Amount for tax years beginning after December 31, 2017 and before January 1, 2026: $12,060,000 ($24,120,000, married couple)

(Sunsets to $5,000,000 in 2026, but portability remains)

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Estate and Gift Tax are “unified”

• Each gift dollar above $16,000 annual exclusion (per donee) is reported to IRS
• Each dollar above $16,000 reduces lifetime exemption, the result is the available exemption at death (estate tax)

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Top rate: 40% (depends on amount of wealth above the exemption)

Recent Policy Proposals (all dead letter, probably)

• Reduce Estate and Gift tax exemption
• proposal: reduce by half (to ~$6,000,000)

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• Eliminate “Stepped Up Basis”

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• Require payment of unrealized “gain” at death of property owner (applied to decedent’s last income tax return)

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• Include “grantor trusts” (irrevocable) in taxable estate
• eliminates “tax free” appreciation

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• Eliminate ‘valuation discounts’ on some entity interests
• “minority interest” and “lack of marketability” of interests tied up in an entity (e.g. LLC)

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Estate Tax Impact on “Average Farm” (Land Only)

• Average farm from the National Agricultural Statistics Service (NASS), categorized by sales (2021 Survey Values).
• NC Average farmland acre value = $4750/ac
• increase of $170 since 2017
• Mean farm acreage for NC is 183 acres
• this average includes very very small farms with lowe asset value

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• $500,000 to $1,000,000 sales = 811 acres average

811/ac x $4750/ac = $3,852,250

• $1,000,000 plus gross sales = 906 acres average

906/ac x $4750/ac = $4,303,500

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Compare at $12,060,000 ($24,120,000 married) exemption until 2026

Compare at $5,000,000 ($10,000,000 married) if TCJA sunsets with no new legislation

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*does not include equipment, stored grain and chemicals, personal wealth, etc.

Present Use Value

• Differential valuation property tax assessment
• Standard tax rate applied to lower value
• Deferred property tax
• ”Abated” after 3 years
• 3 year roll back if property/ownership loses qualification
• Qualified land owned by individual
• 20 acres for forestry (must include forest management plan)
• 10 acres of farmland (row crops, pasture)
• 5 acres for horticulture land
• Must show $1000 gross annual receipts (rolling average)
• Read PUV Use Guide (NCDOR) for scenarios (Google)
• Do not dispose of land without knowing PUV status

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