Agricultural and Natural Resource Issues

Chapter 11 pp. 391-433

2017 National IncomeTax Workbook™

Tax Legislation

1. Cash Accounting2. SE Tax on Rental Income3. DPAD Eliminated?4. Step-up in basis

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Ag Economy Update

1. Farm Economy is still tight.2. Commodity Program payments lower

in 2017 and will be lower in 2018.3. Tax legislation?4. Farm Bill legislation?5. Interest Rates ^

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11/30/2017

Corn Price – Last 20 YearsSource: macrotrends

11/30/2017 Barry Ward, OSU Extension

11/30/2017 Barry Ward, OSU Extension

11/30/2017 Barry Ward, OSU Extension

Receipts 166 199Corn Price $3.70 /bushel $614.57 $737.41ARC/PLC $0.00 $0.00Variable CostsSeed Cost $280 /bag $112.00 $119.00Nitrogen (NH3) $425 /ton $53.77 $65.47P205 (MAP) $455 /ton $26.89 $32.26K20 (Potash) $315 /ton $11.77 $14.13Chemicals $60.42 $60.42Fuel/Diesel $2.20 /gallon $12.66 $12.66

Breakeven Cost / Bu $2.17 $1.97Fixed CostsLabor and Management $75.73 $81.87Machinery Cost $130.45 $130.45Land Rent $187.00 $239.00

Breakeven Cost / Bu $4.67 $4.35ReturnsReturn to Total Costs -$160.76 -$129.52Return to Variable Costs $254.41 $343.79Return to Land $26.24 $109.48

CORN SELECTED BUDGET STATS - 2018Item Input Yield in bushels/acre

11/30/2017 Barry Ward, OSU Extension

Illinois FBFM 2015

Concentration of ag loans in Corn Belt but low ag delinquency rates

Source: FDIC

Commercial agricultural banking performance by state in 2017 Q2

Increase in land operated by large farms

Source: USDA, NASS.

02468

10121416

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Mill

ion

acre

s

Area operated by economic sales class in Ohio

$1,000 to $9,999 $10,000 to $99,999 $100,000 to $249,999$250,000 to $499,999 $500,000 or more

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)

p. 431

Ohio House Bill 49• 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. 431

Agricultural and NaturalResource Issues

1. Agricultural Income & Expenses2. Net Operating Losses3. Buying & Selling Farmland4. Rental Property5. Demolition of Structures6. Disposition of Converted Wetlands

p. 391

Agricultural Income & Expenses

Why is the definition of who is a farmer so important?

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

p. 394

Why is the definition of who is a farmer so important?

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

p. 394

Why is the definition of who is a farmer so important?

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

p. 394

Why is the definition of who is a farmer so important?

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

p. 394

Agricultural Income & Expenses

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

p. 392

Agricultural Income & ExpensesCultivate, Operate, Manage

Owner/tenant must: Participate to a

significant degree in the farming process Bear a substantial

risk of loss in the process

p. 392

Custom Planting—Not a Farmer

John Planter: 11.1 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

p. 392

Contract Swine Barn

Sue Sweeney: 11.2 Owns building & provides care Paid on a per head basis Gets paid a bonus if meets production goals She materially participates & shares risk

p. 392

Agricultural Income & ExpensesFor 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/Evening Warrior

Austin Mitchell: 11.3 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

p. 393

Farming is on IRS Radar!

Schedule F Compliance Audits

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.Horse related activities, ranch operations, and new or

experimental endeavors are especially susceptible 6 Items of interest

pp. 393

Schedule F Compliance AuditsInternal IRS Memo – February 27, 2017

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

pp. 393-394

Farm Income – Schedule F

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

p. 395-398

Farm Expenses – Schedule F

Car & truck Conservation Depreciation & cost recovery Fertilizer & lime Interest payments Rent or lease payments Supplies, repairs & maintenance Seeds & plants Taxes Prepaid expenses

pp. 399-405

Net Operating Losses

Net Operating Losses - Farming

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 harvesting, 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

p. 406- 410

Net Operating LossesFarming Losses – 5 Year C/B

Beaches Ex 11.12 Figure 11.7 – NOL ($80,000) Crop Farm (Sandy) : ($70,000) due to flood Trucking (Rocky): ($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 Forgo the 5 year carryback3-yr: ($10,000) 2-yr: ($70,000)Could elect to forego entire carryback

p. 411

Buying & Selling Farmland

Buying/Selling Farmland

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?

Cost basis – sale, gift, inheritance▪ Basis allocation

p. 416

Buying/Selling Farmland

Special Use Valuation Section 2032A For farm estates of decedents dying in 2017: Aggregate decrease in amount cannot exceed $1,120,000

Qualified heirs may be liable for estate tax if within 10 years after death of the decedent, the heir transfers property or property is no longer used as a farm

p. 416

Buying/Selling FarmlandLand with CRP Contract

Purchaser can become successor-in-interest 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

p. 418

Rental Property

Fixed Cash Lease

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.

39

p. 418

Indexed Cash Lease

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

41

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Tax Implications - Landlord

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

pp. 419-420

Tax Implications - Landlord

Schedule E Can deduct ordinary and necessary expense (taxes,

interest, repairs, insurance, mgmt fees). Cash rent of farmland▪ net income nonpassive (loss is passive)

See Example 11.19

pp. 419-420

Other Tax Notes- Cash Lease

Net Investment Income Tax For higher income earners - cash rental may be

subject to 3.8% NIITCash Rent Tenant Line 24b Prepaid: Deduct if benefit not > earlier of

1. 12 mos > TP first realizes benefit/rights2. End of tax year following year of payment

p. 420

Flexible Cash Leases

Flexible Cash Lease

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.

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Pp 422-423

Rental Property - Flex Lease

Two basic forms:1. Cash lease with a bonus

• Base rent• Additional rent paid if revenue exceeds benchmark revenue

2. Percent of gross income lease• Base rent• Additional rent if agreed upon % of gross revenue exceeds the base

Paid in cash, not crop share Same tax consequences as cash rent lease

pp. 422-423

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.

48

49

Crop Share Lease - Landlord

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 success3. Works ≥ 100 hours over 5 weeks or more4. Materially/significantly involved/production

pp. 420-421

Crop Share Lease - Landlord

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

pp. 420-421

Rental Property - Leasing Personal Property - Machinery

Self-Employment Tax (on Sch C) if1. Not leased with real property and2. Rental activity is a trade or business▪ Primary purpose is income or profit▪ Tax payer continuously/regularly involved

Ex 11.20 – Randy Rogers retires and rents entire equipment line on a 5 year leasing arrangement

p. 423

Rental Property - Leasing Personal Property - Machinery

If sporadic, not Trade or Business, can be reported as “other income” on line 21 on 1040 (expenses included on line 36)

p. 423

Demolition of Structures

Demolition of StructuresI.R.C. §280B

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

pp. 426-427

Demolition of Structures

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

p. 426

Questions?