Tax Guide for Farmers – Basis of Assets, Part 2: Allocating Basis

The Internal Revenue Code provides the laws used in calculating the income and expenses reported when filing federal income tax returns. The Code and supporting court decisions based on the Code are thorough in covering tax situations for individuals and businesses, including how to complete your taxes if you own a farm or run a farming business.

The last article focused on Cost Basis in determining the basis of assets. The focus of this article is Allocating Basis and Capitalization.

Allocating Basis

It is not unusual for a farming business to purchase assets in a group in a single transaction or for an asset to be composed of separate items. When this occurs, allocating basis to these assets or separate items is necessary.

Group of Assets

When you purchase a group of assets for a single lump sum, you must allocate the purchase price across the assets. The amount allocated to each asset is then used for calculating depreciation on each asset, as well as for calculating gain or loss in the event you must dispose of the assets.

If the contract between the buyer and seller specifies the sales price of each asset purchased in the transaction, the sales price should typically be used as the basis for the assets.

Acquiring a Farming Business

If the group of assets you purchase is a farming business, allocating the basis is not as simple as using the sales price of each asset, even if available. Instead, the purchase price of the farming business must first be reduced by the amount of any cash received in the transaction. Then the remaining purchase price is allocated to the farming assets proportionally using the fair market value of each asset.

Capitalization Rules

Capitalization rules in the Code require that certain direct and indirect costs be included in the basis of property, rather than claiming them as expense deductions in the current tax year. You are permitted to deduct these costs over time using amortization and depreciation or as cost of goods sold when you sell, use, or otherwise dispose of the asset.

You must abide by the capitalization rules if any of the following are true:

  1. You produce real or tangible personal property. You are producing property if you build, construct, develop, install, improve, manufacture, or otherwise create the property. In a farming business, you produce property if you grow or raise any agricultural or horticultural commodity, including animals and plants.
  2. You acquire property for resale. Capitalization rules do not apply to property acquired for resale if it is personal property and your average annual gross receipts for the three tax years preceding the current tax year are no more than $10 million.

You do not have to follow the capitalization rules if the property is produced for personal use.

A plant produced in a farming business includes bushes, fruits, nuts, sod, ornamental trees, other crop bearing trees, and other plants that will have more than one crop yield. An animal produced in a farming business includes any bird, fish, poultry, livestock, or sea life.

The direct and indirect costs producing animals and plants include preparatory and preproductive period costs. Preparatory costs include the costs of acquiring animals, plants, seeds, or seedlings. For plants, preproductive costs include the costs of frost protection, harvesting, irrigation, pruning, and spraying. For animals, preproductive costs include feed, pasture maintenance, breeding, and veterinary services.

Exceptions

Capitalization rules do not apply to any animals, any plant with a preproductive period of two years or less, or any costs of replanting plants lost or damaged as the result of casualty. In addition, you can elect not to use the capitalization rules for plants with a preproductive period of more than two years.

What can you do if you have other questions about the basis of assets?

If you have additional questions about taxes related to farming or calculating the basis of your assets, you can get answers from a tax attorney. A tax attorney specializes in understanding the laws in the Internal Revenue Code. A tax attorney, through education and experience, can answer your questions and help reduce the amount of tax you pay.

You can contact a tax attorney by calling the phone number at the top of this web site or completing the form below. Your initial consultation with a tax attorney is free of charge. Any conversation you have with a tax attorney is also completely confidential.

Get the help you need with your income taxes today by getting in touch with a tax attorney.

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by Mark Johnston

Mark has been a contributor to legal web sites related to bankruptcy, tax, and criminal law since 2011. He has an Accounting degree from Texas A&M University.