Thursday, May 31, 2012 3:03 AM
There are three primary elements of depreciation for Federal Income Tax. The three elements are regular depreciation, Section 179 first year depreciation and Bonus Depreciation. The ordering rules are you first take the Section 179, then Bonus depreciation and lastly regular depreciation.
Section 179 deduction has been around since the investment tax credit was eliminated in 1986. The amount of allowable depreciation under Section 179 seems to change every year. For 2011 the deduction limit was $500,000 as long as qualified purchases did not exceed $2.0 million. For 2012 the deduction limit is $139,000 as long as qualified purchases don't exceed $560,000.
For 2013 the deduction limit is scheduled to drop significantly, but these amounts frequently change before the end of the year by action of Congress.
Section 179 deductions are available for new or used purchases of tangible property used in business, and can be elected in any amount between zero and the maximum limit as desired. No Section 179 or Bonus depreciation is allowed for purchases from a related party.
Bonus depreciation first came in to the tax code in 2001, and has been changed several times since. For 2011 the Bonus depreciation deduction was unlimited for 100% of qualified purchases. For 2012 Bonus depreciation deduction is 50% of qualified purchases with no purchase limit. Bonus depreciation is for new assets only with a depreciable life of 20 yrs or less. Passive rental activities can use bonus depreciation but not generally the Section 179 deduction.
Unlike the Section 179 deduction, Bonus depreciation is a take it or not proposition. Meaning if you want to take Bonus depreciation you have to take it on all qualified purchases within a class life or none.
Because Bonus depreciation is allowed on new property only, it recently became important to know when a cow changed from new to used. The tax regulations specify that the day that a heifer gives birth to her first calf she becomes "used". So a bred heifer is new property eligible for either Bonus Depreciation or Section 179 deductions but a cow that has had a calf is eligible for Section 179 deductions but not Bonus Depreciation. Another regulation states that depreciable property can only be depreciated when it is "placed in service". A heifer is "placed in service" the year that she is bred. So you can depreciate bred heifers the year that you buy them but a heifer calf bought in the fall of the year that she is born is normally added to depreciation the year after she is purchased.
Depreciation lives for typical farm and ranch property is as follows:
1) Semi-tractor trucks 3 years.
2) Other vehicles and pickups 5 years.
3) Cows 5 years.
4) Most machinery 7 years.
5) Most horses 7 years.
6) Corrals, fences and grain bins 7 years.
7) Single purpose Ag buildings (calving sheds) 10 years.
8) Wells, most roads 15 years.
9) Machinery and shop buildings 20 years.
A series of revenue rulings indicate that earthen dams and irrigation ditches cannot be depreciated because they lack a definite life. These same earthen dams and irrigation ditches can usually be deducted in the year placed in service as a Conservation Expense. Conservation expenses are limited to those actively engaged in farming or ranching and are limited to 25% of gross income from farming and ranching and are subject to a 9 year recapture provision if the land is sold.
Regular depreciation for farm and ranch property is 150% declining balance based on the above class lives. It does not matter for regular depreciation if the property is new or used. A 40 year old tractor is 7 year property the same as a brand new tractor. An 8 year old cow is 5 year property the same as a 2 year old cow. The tax code does make a distinction on horses, a 12 year or older horse is 5 year property rather than 7 years. You can elect to use straight line depreciation instead of the 150% declining balance if you choose. The election is simply made by the calculation used in the first year.
When depreciable property is sold, the cost is reduced by prior depreciation expense. This includes regular depreciation, Bonus depreciation and Section 179 deductions. For most personal property the gain is ordinary income rather than capital gain to the extent of prior depreciation, this includes breeding livestock, machinery, single purpose Ag buildings, fences, grain bins and vehicles. An example of this is if you bought a heifer for $800 and took full depreciation deductions on the animal and then five years later sold her for $1,200 you would have $800 of ordinary income and $400 of capital gain income.
John Mitchell is a CPA with Casey Peterson & Associates Ltd, Rapid City, SD.