Direct expensing for farm taxes
An option for decreasing net farm profit in a year of higher income is to use direct expensing. This decision can be made after the end of the tax or calendar year and before filing.
First-year Direct Expensing (Section 179) is an election in IRS code that allows businesses like farms to deduct the cost of capital purchases as a tax deductible expense. In 2011 up to $500,000 of personal property capital purchases may be direct expensed if placed in service by the end of the year.
In most cases the capital purchases that qualify are personal property used more than 50% of the time in the business. The property may be new or used. Examples of eligible property include farm machinery, breeding livestock, grain bins and other single purpose agriculture or horticultural structures. In addition, off-the-shelf computer software is currently eligible property. Single purpose structures do not include farm shops or general purpose farm buildings.
There are several limitations that apply for direct expensing. If the farm business purchases and places into service over $2 million dollars’ worth of qualifying property then the $500,000 limit is reduced dollar for dollar. For example if a farm buys $2,125,000 worth of equipment then the amount of First-year Direct Expensing (Section 179) allowed is limited to $375,000. If the business purchases $2,500,000 or more in 2011 then no direct expensing is allowed.
The amount is also limited to the combined taxable income before the deduction derived from the active conduct of all trades or businesses. Section 1231 gains and losses reported on form 4797, such as sales of breeding livestock and machinery are taxable income as well as wages. For example, if a farm bought $300,000 of farm machinery and the net farm income is $125,000 the first-year direct expensing is limited to $125,000. The amount disallowed by this business taxable income limitation can be carried forward against future capital purchases.
Also keep in mind in any year that the asset ceases to be used more than 50% in the active conduct of a trade or business, a portion of the expensed amount is recaptured.
The determination of whether the mid-quarter convention applies due to purchases made in the fourth quarter of the tax year is made after any direct expense deduction and reduction of depreciable basis for credits.
The carryover basis from traded-in property is not eligible for direct expensing, only the extra or boot can be direct expensed. Boot is the cash and/or loans that are used to purchase the asset in addition to the value of the equipment traded for another piece of equipment. If a farmer traded in an old tractor for a new tractor, only the amount paid to dealer beyond the value of the trade-in would qualify for direct expensing. In addition, large SUVs more than 6,000 pounds Gross Vehicle Weight Rating or not more than 14,000 pounds are limited to $25,000 in direct expensing. A business can direct expense a portion of an item and then use regular deprecation on the remaining amount.
Of course, if the taxpayer direct expenses 100% of an item then there is no more depreciation left to expense in future years on that piece even if it still is in use.
For tax years beginning in 2012, maximum direct expensing is $125,000 indexed for inflation with phase out starting at $500,000 of qualified property placed in service. In 2013 maximum is $25,000 with phase out starting at $200,000. It is possible that Congress could increase this amount prior to 2013.
Remember it is always a good idea to review any elections with your tax advisor.