Agricultural & Natural Resources Tax Issues Chris Bruynis David Marrison Barry Ward Associate Professor Associate Professor Assistant Professor bruynis.1@osu.edu marrison.2@osu.edu ward.8@osu.edu 740-702-3200 440-576-9008 614-688-3959
Agricultural and Natural Resource Issues Chapter 11 pp. 391-433 2017 National Income Tax Workbook
Ag Economy Update NIB 1. Farm Bill Payments lower in 2017 and will be lower in 2018. 2. Farm Economy is still tight. 3. New Farm Bill discussions on horizon. 4. Farm sector watching tax reform carefully- especially step up in basis.
Illinois FBFM 2015
11/6/2017 Barry Ward, OSU Extension
11/6/2017 Corn Price Last 20 Years Source: macrotrends
CORN SELECTED BUDGET STATS - 2018 Item Input Yield in bushels/acre Receipts 166 199 Corn Price $3.75 /bushel $622.88 $747.38 ARC/PLC $0.00 $0.00 Variable Costs Seed Cost $280 /bag $112.00 $119.00 Nitrogen (NH 3 ) $450 /ton $56.34 $68.73 P 2 0 5 (MAP) $455 /ton $26.89 $32.26 K 2 0 (Potash) $315 /ton $11.77 $14.13 Chemicals $60.42 $60.42 Fuel/Diesel $2.20 /gallon $12.66 $12.66 Breakeven Cost / Bu $2.18 $1.99 Fixed Costs Labor and Management $76.14 $82.37 Machinery Cost $130.45 $130.45 Land Rent $187.00 $239.00 Breakeven Cost / Bu $4.69 $4.37 Returns Return to Total Costs -$155.52 -$123.42 Return to Variable Costs $260.07 $350.40 Return to Land $31.48 $115.58 11/6/2017 Barry Ward, OSU Extension
11/6/2017 Barry Ward, OSU Extension
11/6/2017 Barry Ward, OSU Extension
CAUV Reform - Ohio House Bill 49 Ohio Biennial Budget Bill Included language to make certain changes to the Current Ag Use Valuation (CAUV) program The Tax Commissioner is required to assume that the holding period for agricultural land is twenty-five years for computing buildup of equity or appreciation with respect to that land. This effectively raises the calculated capitalization rate in the formula which effectively lowers the calculated CAUV value Land enrolled in CRP will be valued at the lowest soil productivity level (recoupment is possible if land is taken out of CRP)
CAUV - Ohio House Bill 49 431 Counties undergoing reappraisal or triennial update in 2017 will see their CAUV values decline by an average of ~31% (taxes due in 2018) This does not necessarily mean that property taxes on these parcels will decline by this amount p.
Agricultural and Natural Resource Issues Topics p. 391 1. Agricultural Income & Expenses 2. Net Operating Losses 3. Buying & Selling Farmland 4. Rental Property 5. Demolition of Structures 6. Disposition of Converted Wetlands
Agricultural Income & Expenses
Why is the definition of who is a farmer so important? p. 394 Exclusion of income from discharge of indebtedness Limit on deducting charitable contribution of a conservation easement Carryback of net operating losses Soil and water conservation expenditures Expenditures for fertilizer, lime, and other materials to enrich, condition, or neutralize soil Domestic production activity deduction Uniform capitalization of reproductive expenses
Why is the definition of who is a farmer so important? p. 394 Recordkeeping for business use of vehicles Method of accounting for corporations engaged in farming Cash method of accounting and inventory method Crop insurance or disaster payments Weather-related sales of livestock Deduction of prepaid expenses Application of the at-risk rules
Why is the definition of who is a farmer so important? p. 394 Material participation for purposes of the passive loss rules Livestock destroyed by disease Disposition of converted wetlands or highly erodible croplands Imputed interest rules Farm income averaging Self-employment tax on rent
Why is the definition of who is a farmer so important? p. 394 Special use valuation of real estate for estate tax purposes FICA taxes on commodity wages FUTA taxes Excise tax on gasoline and diesel fuel used on farms Relief from estimated tax penalties
Agricultural Income & Expenses p. 392 Farmers: Individuals, partnerships, corps that cultivate, operate, or manage farm for gain or profit, as owners or tenants Farm: Agricultural, stock, dairy, poultry, fruit, truck farms, plantations, ranches, and all land used for farming
Agricultural Income & Expenses Cultivate, Operate, Manage p. 392 Owner/tenant must: Participate to a significant degree in the farming process Bear a substantial risk of loss in the process
Custom Planting Not a Farmer p. 392 John Planter: Is engaged in a farming related activity Bears no risk of loss Should use Schedule C If custom work was incidental he would report income on Schedule F
Stock Farm Yep She is a Farmer p. 392 Sue Sweeney: Owns building & provides care Gets paid a bonus if meets production goals She materially participates & shares risk
Agricultural Income & Expenses For Gain or Profit Is there an actual and honest profit objective Taxpayers engaged in hobby farming are not engaged in the activity for purposes of earning a profit and thus are not farmers for income tax purposes. p. 393
Weekend Warrior Not a Farmer p. 393 Austin Mitchell: CPA/attorney inherited farm April-Sept: Up to 40 hours/week on farm Farm fixed up, planted 1,000 trees No budget or plan, no separate acct., no agric. courses/advice $10,000 loss each year..not a farmer
Farming is on IRS Radar!
Schedule F Compliance Audits pp. 393 50 targeted audits to be conducted for 2015 tax year (note: Hobby Farmers using Schedule F) 4/1/2017 to 4/1/2018 Looking at tax returns with high W-2 income and Schedule F expenses. 6 Items of interest
Schedule F Compliance Audits pp. 393-394 1. Whether deductions are truly ordinary and necessary business expenses deductible under I.R.C. 162 2. Whether farmers are properly distinguishing between custom hire expenses and amounts paid for equipment rental and employee wages 3. Whether gasoline, fuel, and oil expenses are proper business expenses 4. Whether mortgage interest is properly attributable to mortgage interest on real property used in the taxpayer s farming business. 5. Whether repairs and maintenance expenses are for the maintenance of farm buildings, machinery, and equipment that do not add to the property s value or appreciably prolong its life 6. Whether expenses for supplies, including amounts paid for prepaid supplies, are properly documented, and fall within proper prepaid limits are properly documented and fall within proper prepaid limits
Farm Income Schedule F p. 395-398 Farm Product Sales Cooperative Distributions Ag Program Payments- ARC/PLC Conservation Reserve Program Payments Commodity Credit Corporation Loans Crop Insurance/Disaster Payments Custom Hire Other Income Disposition of Farm Assets
Farm Expenses Schedule F pp. 399-405 Car & truck Conservation Depreciation & cost recovery Fertilizer & lime Interest payments Rent or lease payments Supplies, repairs & maintenance Seeds & plants Taxes Prepaid expenses
Net Operating Losses
Net Operating Losses - Farming p. 406-410 NOL: Covered in great depth in 2016 NOL: Generally 2 year carryback & 20 forward. Can elect to waive carryback Farming business: Back 5, Forward 20 N/A: Contract harvest g, buying/selling plants/animals grown/raised by others NOL: 3 years for casualty & theft or declared disaster for small business (but not ag). See Example 11.12 page 411
Net Operating Losses Farming Losses 5 Year C/B p. 411 Ex 11.12 Figure 11.7 NOL ($80,000) Crop Farm: ($70,000) due to flood Trucking: ($30,000) due to flood 5-yr c/b: ($70,000) 3-yr c/b: ($10,000) Could waive 5-yr c/b and revert to 2 yrs. Ex 11.13 3-yr: ($10,000) 2-yr: ($70,000) Could elect to forego entire carryback
Buying & Selling Farmland
Buying/Selling Farmland p. 416 Help your farmers by working with them to keep track of basis in farmland (purchase, gift or inheritance). How well do you think your farm clients are tracking basis?
Buying/Selling Farmland Land with CRP Contract p. 418 Does farm ground have CRP Contract? CRP= Conservation Reserve Program https://www.fsa.usda.gov/programsand-services/conservationprograms/conservation-reserveprogram/index
Buying/Selling Farmland Land with CRP Contract p. 418 Purchaser can become successor-ininterest if USDA approves If no succession, seller remains responsible under contract May be obligated to pay back $$ May have to pay liquidated damages Seller adds early term. costs to basis
Buying/Selling Farmland Land with CRP Contract Beginning 1/9/17, early termination opportunity for certain CRP contracts Waives repayment of all previous payments (and interest) if Land transferred to beginning or socially disadvantaged farmer/rancher
Rental Property
Cash Rent Lease p. 418 The cash tenant pays the landlord a fixed amount, usually part in advance, for the use of farm real estate and receives all of the resulting production. The tenant pays all costs of production and thus assumes all production risks (drought, insect, hail, etc.) and all price risks. 40
Indexed Cash Lease NIB A lease that is indexed to a pre-determined parameter Lease amount changes each year based on the parameter change Possible parameters: NASS Ohio Average Cash Rental Rate % Change, AEDE Survey Rental Rate % Change 42
Tax Implications - Landlord pp. 419-420 Reported on Schedule E No SE tax as no material participation Not a trade/business so: No Section 179 expense No soil & water conservation expense No farm income averaging No qualification for estimated taxes
Tax Implications - Landlord pp. 419-420 Can deduct ordinary and necessary expense (taxes, interest, repairs, insurance, mgmt fees). Subject to passive loss rules < 30% unadjusted basis depreciable, net income not passive (net loss is) See Example 11.19
Other Tax Notes- Cash Rent Lease Net Investment Income Tax For higher income earners - cash rental may be subject to 3.8% NIIT Cash Rent Tenant Line 24b Prepaid: Deduct if benefit not > earlier of 1. 12 mos > TP first realizes benefit/rights 2. End of tax year following year of payment p. 420
Flexible Cash Leases
Flexible Cash Lease Pp 422-423 A flexible-cash lease will allow landowners to share some of these risks without becoming subject to self-employment taxes. And, like a fixed-cash lease, the tenant doesn't have to keep track of the landowner's share of expenses. Nor does the landowner have to make grain marketing decisions or other management decisions. 47
Rental Property - Flex Lease pp. 422-423 Two basic forms: 1. Cash base rent + revenue based bonus 2. Rent solely on % split of revenue Generally paid in cash, not crop share For most, same tax consequences as cash rent lease
Crop Share Lease Landlord rents land in exchange for share of crop. Need information on how landowner participates in the farming activity. The share of the crop is determined by each party s contributions to the business. 49
50
Crop Share Lease - Landlord pp. 420-421 Materially participates: SE Tax Sch F No material participation: No SE F4835 Material participation if (1 or more): 1. a)pay 50% direct costs, b) provide 50% tools, c) advise/consults, or d) inspects (needs do at least 3 of these) 2. Regular decision making affecting success 3. Works 100 hours over 5 weeks or more 4. Materially/significantly involved/production
Crop Share Lease - Landlord pp. 420-421 Unlike cash rent landlords, crop share landlords may be eligible for tax provisions that typically apply to only farmers, even if the landlord does not materially participate. Section 179 Soil & Water Expenses Farm Income Averaging Estimated Tax Payments Passive Loss Rules
Rental Property - Leasing Personal Property p. 423 Self-Employment Tax (on Sch C) if 1. Not leased with real property and 2. Rental activity is a trade or business Primary purpose is income or profit Tax payer continuously/regularly involved Ex 11.20 -If sporadic, not Trade or Business, other income line 21
Rental Property - Leasing Personal Property p. 423 Randy Rogers: Retired and rents all his equipment. Since not leased with real property is likely to be trade or business. Pay SE
LLC Rental pp. 424-425 Rental to activity in which TP materially participates: Income not passive, loss is Schedule E, code 7 on line 1b Ex 11.23 Self-Rental, Material Part. TP Sch F rents land from TP s SMLLC
Demolition of Structures
Demolition of Structures I.R.C. 280B pp. 426-427 No deduction allowed for cost of demolishing buildings no deductible loss Costs and losses added to land basis If purchases, uses & depreciates, then demolishes, remaining basis into land
Demolition of Structures p. 426 Polly Ester (Example 11.26) Purchased land & tears down buildings. Has to allocate $5,000 to basis. Does this happen? Chip Monk: (Example 11.27) Purchased land and uses tool shed. Depreciates shed for a few years. When demolishes, puts adjusted basis and demo cost to basis
Demolition of Structures pp. 428-429 Chapter also provides additional demolition examples: Safe harbor for structural modifications (75% rule) Removal of material during repair. Abandoned property Demolition after abandonment Soil & water expenses
Disposition of Converted Wetlands
Disposition of Converted Wetlands Wetlands mitigation: Restore, create, or enhance wetlands in one place to compensate for impact to other wetlands p. 430 Credits granted Requires replacement of all lost wetlands functions, values, acres Ownership retained while easement protects the wetlands
Disposition of Converted Wetlands p. 430 Landowner to impact a wetland purchases offsetting wetland credits Wetland mitigation banks in 10 states One acre restored = one credit For each acre converted to nonwetland, landowner must purchase one credit Credits traded on open market
Disposition/Converted Wetlands 1257 p. 431 Disposition of converted wetlands or highly erodible cropland Gain: Ordinary (F4797) Loss: Long-term capital loss (F8949) Expenses to drain/fill wetlands or prepare for center pivot irrigation systems is added to basis of land
Disposition/Converted Wetlands Converted Wetlands Converted wetlands means any converted wetland: Held by the person whose activities resulted in such conversion p. 431 Held by any other person who at any time used such land for farming
Disposition/Converted Wetlands Converted Wetlands pp. 431-432 Ex 11.34 Sell 10 acres @ $15,000/acre Basis $1,800/acre Investors buying for development 1 acre is wetlands buys credit $11,000 Tile and drain the acre - $2,000 Figure 11.12: Form 4797 9 acres - Part I, wetland acre - Part II
Disposition/Converted Wetlands Converted Wetlands pp. 432-433 Ex 11.35 Sell 10 acres @ $11,500/acre Figure 11.13 Form 4797, Part I 9 Acres Gain of $87,300 Figure 11.14: Form 8949 1 wetland acre - Loss of $3,300
Questions?