As you and other farmers turn your attention from this year’s harvest to the coming year, optimizing your tax strategies should be an essential part of your planning. Agribusinesses like yours can take advantage of farm tax deductions to reduce your taxable income and preserve working capital.
However, proper record-keeping and strategic planning are required to maximize deductions.
One of the first considerations in effective planning is ensuring your business is considered a farm for tax purposes. Under current regulations, more than two-thirds of your gross income must be from farming. Below that threshold, your effort is likely to be considered a hobby farm.
Significant Farming Tax Deductions
Important tax deductions for farms may include:
- Farm income averaging (Schedule J). This option allows farmers to spread a certain amount of income over a three-year period. This can be helpful if you have an income spike from, for example, a robust crop or a property sale.
- Deferred milk payment contracts. A dairy farmer may be able to sell milk to a cooperative under a contract in which payment occurs in a future year.
- Deferred crop insurance proceeds. Under certain circumstances, farmers who report income on a cash basis may have the option to defer crop insurance income to the following year.
- Purchasers of vineyards may be eligible for American Viticultural Area Valuation (AVA) amortization for 15 years after a purchase occurs.
- Tax credits. A farm may be eligible for various federal and state tax credits.
- Self-rentals. Some farms designate their land as a separate entity from the farming operation for tax purposes and pay themselves a fair-market-value rent, allowing them to take advantage of self-employment tax savings for the rent expense deduction on the farming operation and exclude the rent income from self-employment income.
Key Tax Planning Areas to Consider
As a farmer, it can be beneficial to keep the following in mind as you consider your tax plans:
Depreciation on Farm Property
Bonus depreciation provisions allow farmers to deduct 80% of the cost of eligible property for 2023. This percentage will phase down 20% annually until it expires in 2027. Eligible property was expanded under provisions of the Tax Cuts and Jobs Act (TCJA); new or used property with a tax life of 20 years or less generally qualifies.
Similarly, the Section 179 deduction for machinery, vehicles, and qualifying equipment can be used with bonus depreciation (especially as bonus depreciation phases out in future years), but 179 has more limitations.
§263A, Uniform Capitalization (UNICAP) Rules
The uniform capitalization (UNICAP) rules prescribe which costs associated with the production of property for the taxpayer’s own use or resale, or with the acquisition of property for resale, must be capitalized (i.e., included in the property’s basis or inventory costs).
Generally, capitalization rules under 263A require farmers to capitalize pre-productive costs of plants that have a pre-productive period of more than two years. These include direct and indirect costs such as seed purchase, planting, cultivation, irrigation, fertilizer, depreciation, pruning, and similar expenses.
The TCJA exempted businesses with average gross receipts of $26 million or less for the three preceding years from having to apply 263A. This is an attractive opportunity for many farmers, especially tree and vineyard farmers previously required to capitalize pre-productive costs for raising plants that have been planted but have not been placed into service.
If a farmer previously elected out of 263A, but now qualifies for the exemption, the IRS has provided rules on how to revoke the prior election. This allows these taxpayers to use the general depreciation system (GDS) instead of the unfavorable alternative depreciation system (ADS) rules required when electing out of 263A.
Tax Credits
Farmers should also ask about potential tax credits they may qualify for:
- Solar or other renewable credits have returned to the 30% level for projects installed between 2022 and 2032. Installations on business are also afforded depreciation, including bonus depreciation, but the depreciable basis must be reduced by half of the credit.
- For example, a solar installation costing $10,000 would be allowed a 30% credit resulting in a $3,000 credit, and the total depreciable basis from which depreciation may be deducted is $8,500 ($10,000-($3,000*50%) =$8,500).
- Fuel used for farming may provide a credit for the federal tax paid on the fuel.
- Research and development (R&D) is an often-overlooked area. To qualify, a business must be able to demonstrate that certain expenses are related to developing or improving products or processes in its industry.
Net Operating Losses
Generally, net operating loss (NOL) carrybacks were eliminated for NOLs arising in tax years ending after 2020, except for farmers. Farmers can still carryback NOLs up to two years to reduce their taxable income in a preceding year and potentially claim a refund for taxes paid in the carryback year(s). A taxpayer entitled to a two-year carryback of a farming loss can elect to relinquish the NOL carryback period and instead carry the NOL forward to a later year.
Excess business loss limitations are in place for tax years 2017 through 2028. An excess business loss is the excess of the taxpayer’s aggregate deductions attributable to the taxpayer’s trades or business, over the sum of the taxpayer’s aggregate gross income or gain attributable to such business (plus $540,000 for married filing jointly filers, or $270,000 for other filers).
Excess business losses are not allowed and are carried forward as part of the taxpayer’s net operating losses. This could prove problematic for taxpayers relying on these losses to offset other sources of income.
If you have questions about potential farm tax deductions that may be available for you, or would like help optimizing your tax strategies, contact us.
