Keeping farm records for the calendar year and compiling everything at tax time is no one’s idea of fun. Mark Dikeman of the Department of Agricultural Economics at Kansas State University breaks down essential information and terminology used in farm taxes.

Throughout the year, farmers purchase inputs – seed, fertilizer and feed. Many such purchases are consumed within 12 months of purchase. These are deducted as an expense.

In contrast, capital items are longer-life property and won’t be consumed within 12 months. The recovery process occurs through an income tax deduction referred to as depreciation, which accounts for the cost of the item over several years.

Depreciated property in an ag context is generally “owned” property. The property must be used in the business or an income-producing activity and have a determinable, useful life of more than one year. If the property meets those requirements, it qualifies for depreciation. The useful life is important in calculating depreciation.

Several factors must be known for depreciation: the date the item was placed in service, the basis of the item, what depreciation convention will be used, the recovery period, the depreciation method, how much §179 expense deduction will be taken and whether special (bonus) depreciation will be used.

“All of this information is needed to determine depreciation calculations for property,” said Dikeman. “The §179 deduction allows businesses to take an immediate deduction for business expenses related to depreciable assets such as equipment, vehicles and software.”

Dikeman explained each factor involved in depreciation. A piece of property is placed in service when it is ready and available for a specific use.

“The property does not have to be used for that particular use, it just has to be ready and available,” he said. “A planter is purchased on December 12, 2024 and delivered on December 14, but it isn’t used until April 1 of the following year. The date placed in service is December 14 because that is the date of delivery.”

In general, basis is the cost of the property, including expenses for delivery, assembly or installation, and sales tax. For items that are financed, the amount financed is considered part of the cost of the property.

Dikeman said since 2018, there’s a new set of rules for the basis of property when a trade is involved. “That trade-in can make the determining basis complicated,” he said. “For property purchased after 2017, where a trade is involved, the basis of the new property is going to be the total of the portion paid in cash (or financed) plus the amount the dealership allowed on the property that was given up.”

An example of trade-in basis is a farmer who paid $50,000 in cash for a tractor. The farmer traded in an older tractor that the dealer valued at $75,000. Their basis in the new tractor is $125,000 – the original total plus the trade difference of $75,000 allowed by the dealer.

Dikeman said the farmer also has to treat the old tractor as if it were sold and recognize the gain on the $75,000 transaction. So even though the $75,000 didn’t change hands, it’s treated as part of the basis of the property.

The depreciation convention determines the portion of the year the taxpayer can claim depreciation on the property. This aspect is most important in the first year – the year the property is placed in service.

For farm property, machinery, equipment, ag buildings and livestock: In general, the half-year or mid-quarter convention applies. This discourages end-of-year purchases that would allow claiming a half-year depreciation on those purchases.

The recovery period is the number of years property is depreciated. There are two options: the general depreciation system (GDS), which applies most of the time, and the alternative depreciation system (ADS). A taxpayer can use ADS, which in most cases will increase the recovery period or increase the depreciable life and slow or decrease depreciation in the first year the property is placed in service. Dikeman recommends IRS Publication 225 (Farmer’s Tax Guide) for more information on recovery periods or depreciable lives.

Even though the recovery period is a specific number of years, depreciation occurs over one additional year. That’s because in the first year, the farmer is only taking a portion of the total year, so to catch up at the end, the final year of depreciation will also be a partial year.

The depreciation method determines the timing of depreciation deductions. For most farm property with a life of 10 years or less, the default depreciation method is 200% declining balance – which works out to be the most depreciation in the year the item is placed in service.

The §179 expense deduction is an election available to expense part or all of the cost of qualifying property in the year placed in service. This provides flexibility in tax planning.

Qualifying property for the §179 expense deduction includes ag properties, livestock, machinery and equipment, grain storage facilities, single-purpose ag structures, horticultural structures, irrigation equipment and drainage tile. The §179 deduction cannot be used on farm shops or general purpose ag buildings.

Special depreciation, also known as bonus depreciation, allows taxpayers to take a percentage of the property basis in the year the property is placed in service. For 2024, the bonus depreciation allowance is 60% of the cost of an item. Bonus depreciation applies to property with a GDS recovery period of 20 years or less, which means general purpose farm structures would qualify for bonus depreciation.

One of the nuances of bonus depreciation allowance is that it applies by default. If a taxpayer doesn’t want to take this allowance, they make an election not to take it.

“That election is made on a class-by-class basis and once made, that election applies to all property within a particular class life,” said Dikeman. “If I make the election for a seven-year property, I have to apply the election to all seven-year property.”

One of the benefits of depreciation rules in the ag sector is that all the elections are made at the time the tax return is being prepared, which provides considerable flexibility. A farmer may not know what other income is available during the year or late in the year, but making decisions after the fact provides flexibility in tax planning.

Dikeman reminded taxpayers that the information he provided is guidance and not legal or tax advice. Some information may vary by state. In addition to consulting the Farmer’s Tax Guide, he recommended farmers review IRS Publication 946 (How to Depreciate Property).

by Sally Colby