The Internal Revenue Code has specific sections concerning farmers and tax implications of a farming business. One such section addresses the depreciation of assets, which is the focus of this article.
If you purchase or improve property that has a useful life greater than one year, such as machinery or structures, you typically cannot deduct the entire cost of the property in the year of purchase. Rather you must spread the cost over the time you use the property. This is known as depreciation.
Depreciation can be used on most tangible property, including buildings, equipment, furniture, machinery, vehicles, and certain livestock. Although land is tangible property, you cannot depreciate land. You can also depreciate certain intangible property, including computer software, copyrights, and patents.
For you to depreciate property, the property must meet all of the following requirements:
- You must own the property.
- You must use the property in your business or for an income-producing activity.
- The property must have an identifiable useful life.
- The useful life of the property must extend beyond the year you put the property into service.
Property You Own
Property you own is property for which you are the legal owner. This includes property for which you still owe a debt.
You typically cannot depreciate property you lease for use in your business because you do not have ownership of the property. However, you can depreciate any capital improvements you make to the leased property.
You can usually depreciate property you lease to someone else, unless the lease requires that the lessee maintain the property and return the property to you at the same or an equivalent value as when the lease began.
Property Used in Your Business or for an Income-Producing Activity
To depreciate property, you must use the property in your business or for an income-producing activity. If you use the property to produce income, the income must be taxable.
You can depreciate livestock if the livestock was purchased for breeding, dairy, or draft purposes and the livestock is not tracked as inventory. However, you typically cannot depreciate livestock you raise because you deduct the costs associated with raising the livestock.
You cannot depreciate property you use solely for personal activities. However, if you have property that serves a mixed use, you can deduct depreciation related to the portion of the property used for business purposes.
You cannot depreciate inventory, because it is held for resale rather than ongoing use in your business.
Property Has a Determinable Useful Life
To depreciate property, the property must have a determinable useful life. Property with a determinable useful life is property that decays, gets used up, becomes obsolete, or otherwise wears out.
Typically, you can depreciate irrigation systems or wells if you can determine their useful life. However, you cannot depreciate dams, terraces, or ponds typically, because such structures usually do not have a determinable useful life.
Property You Cannot Depreciate
You cannot depreciate certain property, even if the property otherwise appears to qualify as depreciable property.
- You cannot depreciate the cost of land because land does not decay, get used up, or wear out. The cost of land includes costs to clear, grade, landscape, or plant.
- Property placed in service and disposed of in the same year.
- Equipment to make capital improvements.
- Intangible property that does not have a determinable useful life
Where can you additional help with your tax questions or preparation?
You can speak with a tax attorney to get answers to your questions or help in filing your tax return. A tax attorney will have the experience to answer your questions and how to work with the IRS to deal with difficult tax situations.
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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.