Tuesday, December 11, 2018
For tangible depreciable personal property, all or part of the income tax basis can be deducted currently in the year in which the property is placed in service (defined as when property is in a state of readiness for use in the taxpayer's trade or business) under I.R.C. §179, regardless of the time of year the asset was placed in service. See, e.g., Brown v. Comm’r., T.C. Sum. Op. 2009-171. This expense method depreciation amount is an off-the-top depreciation allowance that may be taken at the taxpayer's election each year.
The Tax Cuts and Jobs Act (TCJA) increased the maximum amount a taxpayer may expense under I.R.C. §179 to $1 million. The TCJA also increased the phase-out threshold amount to $2.5 million for tax years beginning after 2017. The $1 million and $2.5 million amounts are indexed for inflation for tax years beginning after 2018. For 2019, the maximum amount that can be expenses under the provision increases to $1,020,000 and the phase-out threshold will be $2,550,000.
But, farm structures present an interesting issue as to whether they qualify for expense method depreciation. Farm buildings don’t count, but what about other types of structures? Where is the line drawn? The eligibility for I.R.C. §179 of certain farm structures – that’s the topic of today’s post.
As noted, for the farmer or rancher, expense method depreciation is potentially available for a wide array of assets. For example, not only can expense method depreciation be claimed on machinery and equipment, as well as purchased breeding stock, pickup trucks and business automobiles, it can also be claimed on tile lines, fences, feeding floors, grain bins, silos and similar “structures” because these structures are not “buildings.”
Eligibility of Farm “Structures”
In general, tangible property is eligible for expense method depreciation if it is I.R.C. §1245 property and is used as an integral part of manufacturing, production or extraction, or constitutes a facility used in connection with manufacturing, production or extraction for the bulk storage of fungible commodities, or is a single purpose agricultural or horticultural structure as defined in I.R.C. §168(i)(13). I.R.C. §1245(a)(3). But, a “building” (or its structural components) is not eligible. I.R.C. §1245(a)(3)(B).
Unfortunately, the term “building” is not defined in I.R.C. §179. The regulations under I.R.C. §1245 specify that language used to describe property in I.R.C. §1245(a)(3)(B) (which includes “a building or structural components”) is to have the same meaning as utilized for the (now repealed) investment tax credit (ITC) and associated regulations. Treas. Reg. §1.48-1(a). The term “building” was defined for investment tax credit purposes (“buildings” were not eligible for investment tax credit) as follows: “The term building generally means any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, packing, display, or sales space.” Treas. Reg. §§1.48-1(e)(1)-(2).
Also, I.R.C. §48(p), even though it has been repealed, contains the current, valid definition of a single purpose agricultural or horticultural structure. That provision (and subsections thereunder) defined property which qualified for the ITC. Tax legislation in 1986 moved that language into I.R.C. §1245 for depreciation recapture purposes. Under that definition, a single purpose ag structure (which is not a farm “building”) is used for housing, raising and feeding a particular type of livestock and their produce and the housing of the necessary equipment. Structures that fit this definition include hog houses, poultry barns, livestock sheds, milking parlors and similar structures. Also included within the definition are greenhouses that are constructed and designed for the commercial production of plants and a structure specifically designed and used for the production of mushrooms. Thus, only livestock structures and greenhouses qualify under this category.
IRS and court guidance. In the context of the ITC, certain the IRS and the courts have provided guidance. This guidance remains instructive on where the line is drawn between a “building” (not eligible for I.R.C. §179) and other structures that are eligible for I.R.C. §179 because they don’t meet the definition of a “building.”
- As to whether ag commodity storage facilities are “buildings,” in Rev. Rul. 66-89, 1966-1 C.B. 7, the IRS set forth two basic criteria for determining what improvements qualify as storage facilities, rather than buildings (for investment credit purposes): (1) the facility must provide storage space but not work space; and (2) the facility must not be reasonably adaptable to other uses.
- Catron v. Comr., 50 T.C. 306 (1968), acq., 1972-2 C.B. 1, involved a pre-fabricated Quonset-type structure used in the taxpayers’ apple farming business. Two-thirds of the structure was devoted to the selecting, grading and boxing of apples. The other one-third of the structure was refrigerated. The refrigerated area was held to not be a building as “other tangible property” that the taxpayer used in connection with agricultural production.
- Similar to the rationale applied in Catron, the Tax Court, in Palmer Olson v. Comr., T.C. Memo. 1970-296, determined that property constitutes a storage facility if it does not include working space.
- In Rul. 68-132, 1968-1 C.B. 14, modified by Rev. Rul. 71-359, 1971-2 C.B. 61, the IRS determined that a controlled temperature facility that provided specialized storage for potatoes for a potato farmer was not “building” despite its outward appearance. It, thus, qualified for investment tax credit. The IRS noted that the cleaning, processing, grading and packaging of the potatoes was carried on in an adjacent building.
- In Rul. 71-359, 1971-2 C.B. 6, the IRS ruled that a structure that was used for the storage of raw peanuts in the course of the taxpayer’s business of buying peanuts from growers and selling peanuts to manufacturers was not a “building.”
- In Merchants Refrigeration Co. of California v. Comr., 60 T.C. 856 (1973), acq., 1974-2 C.B. 3, a large freezer room in which frozen food stuffs were stored in cartons or bags was a storage facility and not a building.
- The Tax Court, in Central Citrus Co. v. Comr., 58 T.C. 365 (1972), determined that “sweet rooms” that occupied approximately one-sixth of a facility and where fruit was stored subject to controlled atmospheric conditions were not buildings. The Tax Court noted that the “sweet rooms” were not reasonably adaptable for other uses.
- In Giannini Packing Corp. v. Comr., 83 T.C. 526 (1984), the Tax Court held that rooms built to cool and preserve fruit were integral parts of production process of the fresh fruit and were not “buildings.”
- In Ltr. Rul. 8227012 (Mar. 30, 1982), the IRS determined that a freezer storage facility for pre-packaged food products was a building because it was similar to a warehouse. It was built on a concrete slab, had roof constructing consisting of structural steel and decking, and was constructed with steel racks from the floor to the ceiling located throughout. It also wasn’t used, the IRS noted, for the bulk storage of fungible commodities.
Hoop structures. There really isn’t any good guidance on the eligibility of “hoop” structures for I.R.C. §179. “Hoop” structures generally fit in the category of a general purpose farm building. At least that’s the likely IRS position. Granted, a fact-dependent argument can be made that a hoop structure is used as an integral part of production or is akin to a bulk storage facility used in connection with production. If that argument prevails, a hoop structure is I.R.C. §1245 property with no class life and a seven-year recovery period. In that case, a hoop structure would be eligible for I.R.C. §179 depreciation (and potentially be eligible for first-year “bonus” depreciation). The key to the determination of a hoop structure’s status is determining whether it is easily adaptable to other uses. If it is, it is properly classified as a “building.” If it is a general purpose ag building, it would not qualify for I.R.C. §179 depreciation.
Significant case. In Hart v. Comr., T.C. Memo. 1999-236, the taxpayers grew and processed tobacco on their Kentucky farm. After harvesting the tobacco in the summer, the taxpayers placed the plants over sticks in the field to cure. After the tobacco cured, the taxpayers transported the plants to a tobacco barn where the plants were hung to cure for several months. The taxpayers acquired a new tobacco barn in 1994. The barn was an enclosed “A-frame” structure with wooden walls and a dirt floor. The structure had three doors that were big enough to allow farm machinery to enter and exit. While the structure did not have a strong foundation, the foundation could be strengthened easily. It wasn’t suitable for the storage of grain because of ventilation and cracks. It also had minimal electrical wiring and fixtures, no insulation and no heating or plumbing. The structure contained a “stripping room” where the taxpayers cured, stripped, graded, baled and boxed tobacco leaves. The stripping room was enclosed only if the weather was cold.
On their tax return, the taxpayers reported the cost of the tobacco barn as $16,730 and elected to deduct $6,750 as expense method depreciation under I.R.C. §179 and depreciate the balance of the structure’s cost over 10 years under the 150 percent declining balance method (as a single-purpose agricultural/horticultural structure). The taxpayers’ position was that the structure was a structure other than a building used either as “an integral part of manufacturing or production” of tobacco or as “a facility used in connection with manufacturing or production.” The IRS, however, claimed that the structure was not entitled to I.R.C. §179 treatment and that its recovery period was 20 years.
The Tax Court upheld the IRS position, determining that the tobacco barn was a “building” rather than a “structure.” The Tax Court noted that the barn looked like a building and it provided working space for employees beyond what was required to cure tobacco. On that latter point, the Tax Court noted that the barn was used for five months out of the year to strip, grade, bale and box tobacco. The employees did more in the barn than simply hanging tobacco plants for curing. The barn also wasn’t a single purpose agricultural/horticultural structure as defined in I.R.C. §1245(a)(3)(D) because the taxpayers didn’t use it exclusively for the commercial production of plants in a greenhouse, or for the commercial production of mushrooms. See, e.g., I.R.C. §168(i)(13). Instead, it was a general-purpose structure that didn’t satisfy the “specific design” or “exclusive use” tests of Treas. Reg. §1.48-10(c)(1) or the “actual use” test of Treas. Reg. §1.48-10(e)(2). Thus, the barn was a “farm building” with a 20-year recovery life. It was also not a land improvement that could be depreciated over 15 years.
The significant increase in the I.R.C. §179 amount in recent years, and particularly as a result of the TCJA, makes the determination of qualified assets very important. On the farm or ranch, “buildings” aren’t eligible, but if a structure provides storage space for ag commodities and can’t easily be adapted to other uses, it just might be eligible property.
Friday, December 7, 2018
The Endangered Species Act (ESA) has the potential to restrict substantially agricultural activities because many of the protections provided for threatened and endangered species under the ESA extend to individual members of the species when they are on private land. Many endangered species have some habitat on private land. Current estimates are that half of the species listed as endangered or threatened have about 80 percent of their habitat on privately owned land.
When a species is listed as endangered or threatened, the Secretary of the Interior (Secretary) must consider whether to designate critical habitat for the species. Once a critical habitat designation is made, activities on the designated land are severely restricted. But how is that designation made, and can a court review the decision to list an area as critical habitat? Those are important questions for landowners, both rural and otherwise. Those questions are also the topic of today’s post – critical habitat designations under the ESA and judicial review.
The ESA establishes a regulatory framework for the protection and recovery of endangered and threatened species of plants, fish and wildlife. 16 U.S.C. § 1531 et seq. The U.S. Fish and Wildlife Service (USFWS), within the Department of the Interior, is the lead administrative agency for most threatened or endangered species, but the National Marine Fisheries Service (NMFS), within the Department of Commerce administers the ESA for certain endangered or threatened marine or anadromous species.
Under the ESA, an “endangered species” is a species which is in danger of extinction throughout all or a significant part of its range other than a species determined by the USFWS to constitute a pest whose protection under the provisions of the Act would present an overwhelming and overriding risk to humans. 16 U.S.C. § 1532(6). A “threatened species” is a species which is likely to become endangered within the foreseeable future throughout all or a significant portion of its range. 16 U.S.C. § 1532(20). The term “species” includes any subspecies of fish or wildlife or plants and any distinct population segment of any species of vertebrate fish or wildlife which interbreeds when mature. 16 U.S.C. § 1532(16).
The Listing Process. Secretary determines when a species is to be listed as either threatened or endangered, and other federal agencies have a duty to conserve listed species by consulting with the FWS when developing their own programs. See, e.g., Sierra Club v. Glickman, 156 F.3d 606 (5th Cir. 1998). As of December 6, 2018, 1,661 species in the United States had been listed under the ESA, with 1,275 species listed as endangered and 386 listed as threatened. Presently, the states with the greatest number of species listed as endangered or threatened are: Hawaii, California, Florida, Alabama and Texas.
An endangered or threatened listing is to be made on the basis of the best available scientific and commercial data without reference to possible economic or other impacts after the USFWS conducts a review of the status of the species. 16 U.S.C. § 1533(b)(1)(A) (2002); 50 C.F.R. 424.11 (20). There is, however, no statutory threshold definition or quantification of the level of data necessary to support a listing decision. Indeed, the information supporting a listing decision need not be credible; only the “best available.”
The Secretary's decision to list a species as endangered or threatened is based upon the presence of at least one of the following factors; (1) the present or threatened destruction, modification, or curtailment of a species' habitat or range; (2) the over-utilization for commercial, sporting, scientific or educational purposes; (3) disease or predation; (4) the inadequacy of existing regulatory mechanisms; or (5) other natural or manmade factors affecting a species' continued existence. 16 U.S.C. § 1533(a)(1). The USFWS may decline to list a species upon publishing a written finding either that listing is unwarranted or that listing is warranted, but that the USFWS lacks the resources to proceed immediately with the proposal. 16 U.S.C. § 1533(b)(3)(C)(ii).
Ever since the effective date of the 1982 amendments to the ESA, when a species is listed as endangered or threatened, the Secretary must designate critical habitat for the species. See Center for Biological Diversity v. United States Fish & Wildlife Service, 450 F.3d 930 (9th Cir. 2006). “Critical habitat” is the specific area within the geographical range occupied by the species at the time of listing that is essential to the conservation of the species. Critical habitat may also include specific areas outside the geographical area occupied by the species at the time it is listed if the USFWS determines that such areas are essential for conservation of the species. 16 U.S.C. §1532(5)(A). However, critical habitat need not include the entire geographical range which the species could potentially occupy. 16 U.S.C. § 1532(5). In making a critical habitat determination, the USFWS must consider economic impacts and other relevant impacts, as well as best scientific data. See, e.g., New Mexico Cattle Growers Association v. United States Fish and Wildlife Service, 248 F.3d 1277 (10th Cir. 2001). The failure to consider the economic and social impacts of a critical habitat designation at the time of the designation can be cause to set aside the designation. Home Builders Association of Northern California, et al. v. United States Fish and Wildlife Service, 268 F. Supp. 2d 1197 (E.D. Cal. 2003). The USFWS may exclude any area from critical habitat if the benefits of the exclusion outweigh the benefits of specifying the area as critical habitat, unless the USFWS determines on the basis of best scientific and commercial data available that the failure to designate an area as critical habitat will result in the extinction of the species. 16 U.S.C. § 1533(b)(2).
Under the facts of Weyerhaeuser Co. v. United States Fish & Wildlife Service, No. 17-71, 2018 U.S. LEXIS 6932 (U.S. Sup. Ct. Nov. 27, 2018), the USFWS, in 2001, listed the dusky gopher frog as an endangered species after determining that its wild population had dwindled to about 100 that were found at a single pond in Mississippi. It’s habitat had covered coastal areas of Alabama, Louisiana and Mississippi in certain open-canopy pine forests that have since been almost entirely replaced with urban development, agricultural operations and closed-forest timber farming enterprises. Upon making the designation, the Secretary had to designate the critical habitat for the frog. It did so in 2010. Among the areas designated as critical habitat was a 1,544-acre site in Louisiana where the frog species had last been seen in 1965. While that acreage was largely comprised of closed-canopy timber, it contained five ephemeral ponds and the USFWS believed that the tract met the statutory definition of “unoccupied critical habitat” because it could be a prime breeding ground for the frog. The USFWS then issued a report on the probable economic impact of designating the tract (and the other areas) as critical habitat.
The plaintiff owns part of the 1,544-acre tract and leased the balance from a group of landowners that had plans for development of the portion of the tract that they owned. Those development costs could amount to over $30 million (in timber farming and development) if the USFWS barred all development on the tract. But, according the USFWS, those potential costs would not be “disproportionate” to the conservation benefits of the designation. Consequently, the USFWS decided to not exclude the 1,544-acre tract from the frog’s critical habitat.
The plaintiff and the landowners sued to vacate the designation on the basis that the tract couldn’t be designated as critical habitat because it hadn’t been habitat for the frog since 1965 and couldn’t be habitat without significant modification. The plaintiff also challenged the decision of the USFWS not to exclude the tract from the frog’s critical habitat on the basis that the USFWS had failed to adequately weigh the benefits of designating the tract against the economic impact of the designation. The claim was that the USFWS used an unreasonable methodology for estimating economic impact and failed to consider certain categories of costs.
The trial court upheld the designation on the basis that the tract fit the definition of “unoccupied critical habitat” which only required the USFWS to decide that the tract was essential for the frog’s conservation. On appeal, the U.S. Court of Appeals for the Fifth Circuit affirmed on the basis that that definition of “critical habitat” required a “habitability” requirement. The appellate court also determined that the decision of the USFWS was not subject to judicial review.
On further review, the Supreme Court unanimously reversed 8-0 (Justice Kavanaugh did not participate). Chief Justice Roberts wrote the Court’s opinion, and pointed out that to be “critical habitat,” the designated area must first be “habitat.” Indeed, the Court pointed out that once a species is designated as endangered, the Secretary must designate the habitat of the species which is then considered to be critical habitat. 16 U.S.C. §1533(a)(3)(A)(i). That also applied in the context of unoccupied critical habitat that is determined to be essential for conservation of the species – the area must be “habitat.” Because the appellate court did not interpret the term “habitat” (the appellate court simply concluded that “critical habitat” was not limited to areas that were “habitat”), the Supreme Court vacated the appellate court’s opinion and remanded on this issue.
The Supreme Court also disagreed with the appellate court’s holding that the determination of the USFWS to not exclude the tract as critical habitat was not subject to judicial review. The Supreme Court noted that the plaintiff’s claim involving the alleged improper weighing of costs and benefits of the designation as critical habitat was the type of claim that the federal court’s routinely review when determining whether to set aside an agency decision as an abuse of discretion. Thus, the Supreme Court also vacated this part of the appellate court’s decision and remanded on the issue.
The case is important to private landowners for a couple of reasons. First, on remand the appellate court will have to redetermine the designation of the frog’s critical habitat on the basis that it first must actually be habitat for the frog. There is a “habitability” requirement when the Secretary designates an area as “critical habitat.” Second, the USFWS doesn’t get a free pass when designating an area as critical habitat. That designation is subject to judicial review (as are all USFWS decisions to decline to list a species).
Tuesday, December 4, 2018
Next week, on December 12-13 the final KSU Tax Institute will be held live from the Memorial Union at Pittsburg State University. The two-day event will be simulcast live over the web. It’s a chance to get more education on the new tax law and pick up on some of the important year-end tax planning opportunities under the Tax Cuts and Jobs Act (TCJA).
The KSU Tax Institutes started in late October and finish up at PSU next week. During this timeframe, we have continued to get dribs and drabs of additional information from the IRS and the Treasury about certain aspects of the TCJA. While we don’t have final regulations on the new pass-through business deduction for non-C corporate businesses, the final regulations might be issued by the time of the seminar next week. If that happens, I would especially encourage you to take part either in the live presentation or the webinar. I will cover the QBID in detail on Day 2 – December 13. I will go through many examples and show the practical application of how the deduction works and the best way to structure the business to best take advantage of the new provision. As a web participant, you will be able to interact and have your questions heard and answered.
While the seminar is not exclusively (or even primarily) devoted to ag-related tax issues, I will spend a good deal of time on Day 2 addressing planning concepts for farmers and ranchers as well as other small businesses.
You can register for next week’s seminar/webinar here: https://www.agmanager.info/events/kansas-income-tax-institute
If you are looking to fulfill an ethics requirement. I will be offering a 2-hour ethics session along with Prof. Lori McMillan, my tax colleague at Washburn Law school. The event will be the afternoon of Dec. 14 live from the law school in Topeka and will also be simulcast over the web. You can register for the ethics session here: http://washburnlaw.edu/employers/cle/taxethicsregister.html
Monday, December 3, 2018
Partnerships are a common entity form for farming operations. This is particularly true when the farming operation participates in federal farm programs. A general partnership is the entity form for a farming operation that can result in the maximization of federal farm program payments. But, tax issues can get complex when a partner sells or exchanges a partnership interest. In addition, the 20 percent deduction for non-C corporate businesses may also come into play.
The tax issues surrounding the sale or exchange of a partnership interest – that’s the topic of today’s post.
When a partner sells or exchange a partnership interest to anyone other than the partnership itself, the partner generally recognizes a capital gain or loss on the sale. I.R.C. §741. That’s a good tax result for capital gain because of the favorable tax rates that apply to capital gain income, but not a good tax result if a loss is involved because of the limited ability to deduct capital losses (e.g., they offset capital gain plus $3,000 of other income for the year). When a partner sells his interest in the partnership to the partnership in liquidation of the partner’s interest, the liquidating partner generally does not recognize gain (except to the extent money is received that exceeds the partner’s basis in the partnership interest or the partner is relieved of indebtedness). The liquidating partner receives a basis in the distributed property equal to what his basis had been in the partnership interest.
The general rule that a partner’s sale or exchange of his partnership interest triggers capital gain doesn’t apply to the extent the gain realized on the transaction is attributable to “hot assets.” “Hot assets” (as defined under I.R.C. §751) are unrealized receivables or inventory items of the partnership. In essence, “hot assets” are ordinary income producing assets that have not already been recognized as income, but eventually would have been recognized by the partnership and allocated to the partner in the ordinary course of partnership business and taxed at ordinary income rates. The partner’s sale or exchange of their interest merely accelerates the recognition of the income (such as with depreciation recapture). Thus, the income on the transaction is recharacterized from capital to ordinary. I.R.C. §751(a). The rationale for the recharacterization is that if the partnership were to sell such “hot assets,” ordinary income or loss would be recognized on the sale. Thus, when a partner sells or exchanges a partnership interest, the partner should recognize ordinary income on the portion of the income from the sale of the partnership interest that is attributable to the “hot assets.” If this recharacterization rule didn’t apply, a partner would be able to transform what would have been ordinary income into capital gain by selling or exchanging their partnership interest.
Similarly, when a partnership distributes property to a partner in exchange for the partner’s interest in the “hot assets” of the partnership, the transaction may be treated as sale or exchange of the hot assets between the partner and the partnership that generates ordinary income. It is possible, and perhaps frequent, for a partner involved in farming to recognize ordinary income and a capital loss, even though the partner had an overall gain on the sale. The ordinary income is taxed immediately, but the capital loss is limited as described above.
Types of “Hot Assets”
Unrealized receivables. There are three categories of unrealized receivables: (1) goods; (2) services; and (3) recapture items. I.R.C §751(c) defines the term “unrealized receivables” as including, “to the extent not previously includible in income under the method of accounting used by the partnership, any rights (contractual or otherwise) to payment for (1) goods delivered, or to be delivered, to the extent the proceeds therefrom would be treated as amounts received from the sale or exchange of property other than a capital asset, or (2) services rendered, or to be rendered.” In addition, the term “unrealized receivables” includes not only receivables, but also depreciation recapture. See, e.g., Treas. Reg. §§1.751-1(c)(4)(iii) and (v).
In the farming context, the “goods” terminology contained in the definition of “unrealized receivables” would include property used in the trade or business of farming that is subject to depreciation or amortization as defined by I.R.C. §1245. Included in the definition of I.R.C. §1245 property is personal property (I.R.C. §1245(a)(3)(A)) such as farm equipment and machinery. Also included in this definition are horses, cattle, hogs, sheep, goats, and mink and other furbearing animals, irrespective of the use to which they are put or the purpose for which they are held. Treas. Reg §1.1245-3(a)(4). The definition also includes certain real property that has an adjusted basis reflective of accelerated depreciation adjustments. I.R.C. §1245(a)(3)(C). That would include such assets as farm fences and farm field drainage tile. It also includes grain bins and silos by virtue of a definitional provision including a facility that is used for the bulk storage of fungible commodities. I.R.C. §1245(a)(3)(B)(iii). In addition, the definition includes single purpose agricultural or horticultural structures as defined in I.R.C. §168(i)(13). I.R.C. §1245(a)(3)(D).
The “goods” terminology also includes real property defined by I.R.C. §1250 that has been depreciated to the extent that accelerated depreciation incurred to the date of sale is in excess of straight-line depreciation. Farm property that falls in the category of I.R.C. §1250 property includes barns, storage sheds and work sheds. If these properties are sold after the end of their recovery period, there is no ordinary income. Also, included in this definition is farmland on which soil and water conservation expenses have been recaptured. I.R.C. §751(c); IRC §1252(a).
The “unrealized receivables” definition also includes rights (contractual or otherwise) to payment for goods delivered or to be delivered to the extent that the payment would be treated as received for property other than a capital asset, or services rendered or to be rendered to the extent that the income from such rights to payment was not previously included in income under the partnership’s method of accounting. The rights must have arisen under contracts or agreements that were in existence at the time of the sale or distribution, although the partnership may not be able to enforce payment until a later time. Treas. Reg. §1.751-1(c)(1). Thus, in the ag realm, the definition includes the present value of ordinary income attributable to deferred payment contracts for grain and livestock, installment notes for assets sold under the installment method, cash rent lease income, and ag commodity production contracts.
Inventory. The other category of “hot assets,” inventory items, includes stock in trade or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the tax year, and property the taxpayer holds primarily for sale to customers in the ordinary course of business. I.R.C. §751(d) referencing I.R.C. §1221(a)(1). Whether a taxpayer holds property as a capital asset or for use in the ordinary course of business is a dependent on the facts. See, e.g. United States v. Winthrop, 417 F.2d 905 (9th Cir. 1969). For many farm partnerships, inventory items that constitute “hot assets” might include harvested crops, livestock that are being fed-out, poultry, tools and supplies, repair parts, as well as crop inputs (e.g., seed, feed and fertilizer) not yet applied to the land. On the other hand, an unharvested crop is not included in the definition of “inventory” if the unharvested crop is on land that the taxpayer uses in the trade or business that has been held for more than a year, if the land and the crop are sold or exchanged (or are the subject of an involuntary conversion) at the same time and to the same person. I.R.C. §1231(b)(4).
Inventory also includes any other property that, if sold by the partnership, would neither be considered a capital asset nor I.R.C. §1231 property. I.R.C. §751(d)(2). I.R.C. §1231 property is real or depreciable business property held for over a year (two years for some livestock). Thus, for a farm partnership, included in the definition of “inventory” by virtue of not being I.R.C. §1231 property would be single purpose agricultural or horticultural structures, grain bins, or farm buildings held for one year or less from the date of acquisition (I.R.C. §1231(b)(1); personal property (other than livestock) held for one year or less from the date of acquisition (Id.); cows and horses held for less than 24 months from the date of acquisition (I.R.C. §1231(b)(3)(A)); and other livestock (regardless of age, but not including poultry) held by the taxpayer for less than 12 months from the date of acquisition (I.R.C. §1231(b)(3)(B)).
Qualified Business Income Deduction
The Tax Cuts and Jobs Act (TCJA) creates new I.R.C. §199A effective for tax years beginning after 2017 and before 2026. The provision creates an up to 20 percent deduction from taxable income for qualified business income (QBI) of a business other than a C corporation. To be QBI, only ordinary income is eligible. Income taxed as capital gain is not. If gain on the sale or exchange of a partnership interest involves “hot assets,” the gain is taxed as ordinary income. Is it, therefore, QBI-eligible?
Under Prop. Treas. Reg. §1.199A-3, any gain that is attributable to a partnership’s hot assets is considered attributed to the partnership’s trade or business and may constitute QBI in the hands of the partner. Thus, if I.R.C. §751(a) or (b) applies on the sale or exchange of a partnership interest, the gain or loss attributable to the partnership assets that gave rise to ordinary income is QBI. Given the potentially high amount of “hot assets” that a farm partnership might contain (particularly when depreciation recapture is considered), the QBI deduction could play an important role in minimizing the tax bite on sale or exchange of a partnership interest.
When a partnership interest is sold or exchanged, the resulting tax issues have to be sorted out. An understanding of what qualifies as a “hot asset” helps in properly sorting out the tax consequences. In addition, the new QBI deduction can help soften the tax blow.
Thursday, November 29, 2018
The tax law is structured to tax income less the cost of producing the income. Over time, assets wear out or cease to be useful with their cost, in effect, being consumed during their period of usefulness in the farming or ranching business. In recognition of this cost, the tax law allows an annual deduction for depreciation. In addition, in some instances the total allowable depreciation for the asset can be claimed entirely in the first year that the taxpayer places the asset in service.
In general, depreciation is allowable on all tangible and intangible property with a limited useful life of more than one year that is used in the trade or business of farming or ranching or held for the production of income. Property that is depreciable includes business machinery and equipment, buildings, patents, purchased livestock and property held for rental. Property that is generally not depreciable includes inventories or stock in trade, a building used only as a residence and an automobile used only for pleasure. Land is not depreciable because it doesn’t have a determinable useful life.
Farmers and ranchers do encounter some unique situations that raise the question of whether an allowance for depreciation is available. Assets that are sufficiently similar to land may be non-depreciable because they don’t have a determinable useful life.
Non-depreciable farm assets due to the lack of a determinable useful life – that’s the topic of today’s post.
Agricultural operations can have several unique assets that aren’t depreciable because they don’t have a determinable useful life.
Grazing preferences. In general, grazing preferences are not be depreciable or amortizable. In Uecker v. Comr., 81 T.C. 783 (1983), aff’d, 766 F.2d 909 (5th Cir. 1985), the court held that grazing privileges had an indeterminant life because the taxpayers had preferential application and renewal privileges under state and federal law. They weren’t depreciable under I.R.C. §178 because of the taxpayers' ability to renew them indefinitely.
The same result was reached in Shufflebarger v. Comr., 24 T.C. No. 90 (1955). Under the facts of the case, the taxpayers acquired a portion of a summer allotment of grazing privileges in a national forest. They amortized the cost of acquiring the grazing privileges deducted it. The IRS disallowed the deduction on the basis that the rights had an indefinite duration. The Tax Court agreed. The same result was reached in Central Arizona Ranching Company v. Comr., T.C. Memo. 1964-217, a case involving state and federal land leases. Also, in Priv. Ltr. Rul. 8327003 (Mar. 17, 1983), the IRS determined that a taxpayer’s interest in a state grazing rights lease did not qualify as real property for purposes of a tax deferred exchange under I.R.C. §1031, but it was not subject to depreciation or amortization deductions under I.R.C. 167. The IRS noted that the terms of the lease were of indefinite duration.
But, a change in the facts could lead to a different conclusion if those facts reveal that the life of the grazing privilege has a certain end point, such as when the rights are dependent on the supply of a natural resource that will eventually be depleted.
Earthen irrigation ditches and levees. In Rev. Rul. 69-606, 1969-2 C.B. 33, the IRS ruled that the cost allocated to earthen watering tanks or "ponds" that were constructed by a prior owner on land that the buyer leased to ranchers was not recoverable through depreciation because it didn’t have a determinable useful life. The IRS also ruled that the buyer couldn’t recover the allocated cost as a soil and water conservation expense. having an indeterminate life, constructed by prior owners on land purchased and leased to ranchers. The Tax Court concluded similarly in Wolfsen Land & Cattle Co. v. Comr., 72 T.C. 1(1979). In that case, the taxpayer bought a ranch that had an extensive irrigation system on over 17,000 acres. The Tax Court upheld the IRS determination that the system was no depreciable because it had an indeterminant useful life. The Tax Court noted that the evidence revealed that consistently repairing the system would result in the system lasting indefinitely.
However, some cases have held dams and ponds to be depreciable if a definite useful life can be demonstrated. For example, In Rudolph Investment Corp. v. Comr., T.C. Memo. 1972-129, earthen water tanks and dams were determined to have a ten-year useful life. In Rev. Rul. 75-151, 1975-1 C.B. 88, the IRS pointed out that the question of whether dams, ponds, canals and similar structures are depreciable depends on a factual determination that the asset is actually exhausting and that such exhaustion is susceptible of measurement. But, for farmers and ranchers, a current deduction under I.R.C. §175 is available for expenditures incurred for earthen terraces and dams which are non-depreciable. Of course, the qualifications for I.R.C. §175 must be satisfied.
Permanent Pastures. Permanent pasture is generally defined as land that is used to grow grasses or other forage naturally or through cultivation and is not included in a crop rotation for five years or longer. Permanent pastures have been held to be depreciable. For example, in Johnson v. Westover, 55-1 USTC ¶9,421 (S.D. Cal. 1955), the taxpayer purchased a ranch that included 200 acres of permanent pasture that had been planted with various grasses about five years earlier. The court determined, based on the evidence, that the pasture should be replanted at the end of 10 years to maintain its economic usefulness. At the time of purchase, the evidence showed that the pasture had a remaining life of five years.
Government Allotments or Quotas. Many farmers participate in federal farm programs. Particularly under prior farm bills, farmers were required to participate in acreage allotments. An acreage allotment is a particular farm’s share, based on its historic production, of the national acreage needed to produce sufficient supplies of a particular crop. In essence, an allotment represents the federal government’s attempt to micro-manage production of certain types of crops. These allotments have been held to not be depreciable due to a lack of a determinable useful life. For example, in Wenzel v. Comr., T.C. Memo. 1991-166, the Tax Court addressed the peanut base acreage allotment as part of the federal farm programs was depreciable. The Tax Court noted that wule the program had been controversial for some time, it continued to be reauthorized by subsequent farm bills. Thus, the Tax Court determined that the peanut program was a stable program that would continue unless the Congress took action to terminate it. Because the actions of Congress were completely unpredictable, the Tax Court held that the peanut program base acreage allotment was indeterminant and the associated cost to the taxpayer was not depreciable. Later, in C.C.A. 200429001 (Jul. 16, 2004), the IRS noted that three additional farm bills had become law since the Tax Court’s ruling in Wenzel and the peanut program continued. That lead the IRS to conclude that the duration of the peanut program could not be determined with reasonable certainty or accuracy. Consequently, the IRS determined, the peanut base acreage allotment did not have a determinable useful life and could not be depreciated.
But a transferable right to receive a premium price for a fixed quantity of milk in accordance with a regional milk marketing order has been held to be amortizable (e.g., the cost could be spread over the useful life – 15 years) when it has a statutory expiration date and is not expected to be renewed. For example, in Van de Steeg v. Comr., 60 T.C. 17 (1973), aff’d., 510 F2d 961 (9th Cir. 1975), the taxpayers were dairy farmers who marketed their milk production subject to a Federal Milk Marketing Order. On several occasions they purchased an intangible asset (referred to as a "class I milk base") which they used in their dairy business. They claimed depreciation for the milk base and IRS disallowed the deduction on the basis that the asset had an indeterminable useful life – it depended on the will of the Congress whether or not to extend the program. The Tax Court (affirmed by the Ninth Circuit) held that the program that created the class I milk base always contained an express termination date and the existence of two extensions did not change the fact that a termination date always existed, even though the date had changed. While the IRS disagrees with the Van de Steeg opinion, it did announce that it would follow it. Rev. Rul. 75-466, 1975-2 C.B. 74.
Drilling Costs for Wells. Drilling costs for wells are not depreciable, but parts of wells, such as piping and casings are. See, e.g., Rev. Rul. 56-599, 1956-2 C.B. 122. However, there is language in a Treasury Regulation that indicates that wells might be depreciable. See, e.g., Treas. Reg. §1.175-2(b)(1). In addition, the fact that the IRS has previously ruled that water wells were eligible for the investment tax credit (when it was available), bolsters the argument that water wells are depreciable. To be eligible for the investment tax credit, the property at issue had to be depreciable property. See, e.g., Rev. Rul. 72-222, 1972-1 C.B. 17; Rev. Rul. 81-120, 1981-1 C.B. 20.
Landscaping and Land Modification Costs. If a farmer or rancher incurs costs associated with landscaping or modifying the land (dirt moving) to construct a building that will be used in the farming business, the costs are likely depreciable. Support for this position can be found in Rev. Rul. 74-265, 1974-1 C.B. 56. Under the facts of the ruling, the taxpayer constructed and operated a garden-type apartment complex on several acres. The surrounding area was landscaped according to an architect's plan to conform it to the general design of the apartment complex. The expenditures for landscaping included the cost of top soil, seeding, clearing and grading, and planting of perennial shrubbery and ornamental trees around the perimeter of the tract of land and immediately adjacent to the buildings. The replacement of the apartment buildings after the expiration of their useful lives would destroy the immediately adjacent landscaping, consisting of perennial shrubbery and ornamental trees. The IRS ruled that the perennial shrubbery and ornamental trees immediately adjacent to the apartment buildings were depreciable because the replacement of the buildings would destroy the landscaping. That meant that the land preparatory costs could be recovered through depreciation deductions over the established useful life of the apartment buildings.
Logging Roads, Bridges and Culverts. Logging roads, bridges and culverts are depreciable if the taxpayer can establish that the roads have a determinable life. In one instance, the IRS ruled that a road did have a determinable useful life that could be determined by the amount of time it took to harvest trees that were reachable by the road. Rev. Rul. 88-99, 1988-2 C.B. 33. Under the facts of the ruling, the taxpayer built roads in order to harvest timber, to transport the logs cut from the timber to its facilities for processing, and to carry out general management activities. The taxpayer wanted to depreciate two of the roads. One road was to be maintained so that the taxpayer could use it for an indefinite period of time to manage and harvest timber. The IRS ruled that the roadbed could not be depreciated, but that the associated surface, bridges and culverts could be because they each had determinable useful lives. The other road was to be abandoned after four years, and the useful lives of all parts of the road (roadbed, surface, bridges, culverts, etc.) would terminate when the timber harvest and reforestation work was completed that the road was associated with. Thus, this road could be depreciated.
In a Tax Court case, the taxpayers were allowed to depreciate paved lots that were used in a cattle operation. Eldridge v. Comr., T.C. Memo. 1995-384. The court based its determination on the fact that the taxpayers maintained the horse barn and associated paved areas primarily for use in their cattle-raising activity. The horses housed in the barn were used by the taxpayers to move cattle from one pasture to another, and the Tax Court determined that the horse barn was maintained primarily for use in the cattle-raising activity which was engaged in for profit.
There are many unique items on a farm or ranch that present tricky issues with respect to depreciation because they don’t clearly have a determinable useful life. But, if a determinable useful life can be determined, a deduction for depreciation is available if the asset is used in the taxpayer’s trade or business or for the production of income.
Tuesday, November 27, 2018
Easements are a commonly encountered in agricultural settings. An easement does not give the holder of the easement a right of possession, but a right to use or to take something from someone else's land. To the holder of the easement, the easement is a right or interest in land, but to the owner of the real estate subject to the easement, the easement is an encumbrance upon that person's estate.
Easements may take several forms. Most easements are affirmative that entitle the holder to do certain things upon the land subject to the easement. A negative easement gives its holder a right to require the owner of the land subject to the easement to do or not to do specified things with respect to that land. For example, a negative easement could be a right-of-way, a riparian right, a right to lateral and subjacent support (see, e.g., Ohio Rev. Code. §§723.49-.50), a surface water flowage easement, a manure easement, a soil retention easement or an easement to be free from nuisances, just to name a few.
But, does the law recognize a negative easement for light, air or view? It’s an interesting question, and the issue comes up in ag settings more often than would be suspected. It’s also the topic of today’s post – whether the law recognizes a negative easement for light, air or view.
General rule. Negative easements are synonymous with covenantal land restrictions and are similar to certain “natural rights” that are incidents of land ownership. However, most American courts reject the English “ancient lights” doctrine. That means that American courts typically refuse to recognize a negative easement for light, air and view. This was the result, for example, in Fontainebleau Hotel Corp. v. Forty-Five Twenty-Five, Inc., 114 So.2d 357 (Fla. App. 1959). In the case, a hotel’s additional floors added to the top of the existing building cast a shadow over an adjacent hotel’s beach frontage. The complaining hotel asserted that the other hotel couldn’t add the additional floors to its building because the adjacent hotel had a negative easement over the other hotel’s property for light, air and view. The court rejected the claim on the basis that American law does not recognize a negative easement for light, air or view.
Exception. However, if light, air or view is obstructed out of spite or malice, an American court might determine that a negative easement exists. In other words, if a property owner's interference with a neighboring owner's light, air or view is done maliciously, the court may enjoin the activity as a nuisance. For example, in Coty v. Ramsey Associates, Inc., 149 Vt. 451, 546 A.2d 196 (1988), the court enjoined the defendant's “spite farm” on the basis that it constituted a nuisance. There was no question that the hog “farm” at issue was created purely out of maliciousness against an adjoining landowner. Thus, the court held that the adjoining landowner that had been harmed held a negative easement over the hog “farm” for light, air and view. In addition to the actual damages that the hog farm created, the court imposed substantial punitive damages. The conduct of the hog farm owner was incredibly egregious.
In Rattigan v. Wile, 445 Mass. 850, 841 N.E.2d 680 (2006), the parties were adjoining property owners. The defendant had outbid the plaintiff for the tract that the defendant purchased. That fact upset the plaintiff and the plaintiff then successfully challenged the defendant’s building permit. The result was that the defendant could not build on his tract as desired without being in violation of applicable zoning bylaws. The defendant retaliated against the plaintiff by flying his helicopter near the plaintiff’s property and otherwise harassing the plaintiff. The plaintiff sued, and the court entered an injunction against the defendant that also barred the defendant from putting portable toilets on the property line between the parties. The defendant appealed, claiming (in essence) that the plaintiff did not have any negative easement for light, air or view over the defendant’s property. However, the appellate court affirmed the trial court’s order of injunctive relief on the basis that the defendant’s conduct constituted a nuisance. The appellate court also determined that the proper measure of damages was the loss of rental value ($318,000 plus some additional out-of-pocket costs) attributable to the plaintiff’s property. The appellate court, however, modified the trial court’s permanent injunction so as to not limit the defendant’s legitimate uses of his property.
The issue of maliciousness or “spite” often arises with respect to fences. In 1887, Massachusetts enacted one of the earliest “spite fence” statutes in the United States which declared such a fence to be a private nuisance. Mass. Gen. Laws Ch. 348, §1 (1887); presently codified as Mass. Ann. Laws Ch. 49, §21. A “spite” fence is one that is an overly tall structure that is constructed with no legitimate purpose other than to obstruct an adjoining landowner’s light, air or view. For example, in Rice v. Cook, 115 A.3d 86 (Maine 2015), the parties disagreed over the boundary to their adjoining tracts. Neither party knew where the actual boundary was until a survey was completed in 2008, but the survey result upset the defendant and he erected what the court deemed to be a “spite fence” under Maine law which specifies that “[a]ny fence or other structure in the nature of a fence, unnecessarily exceeding 6 feet in height, maliciously kept and maintained for the purpose of annoying the owners or occupants of adjoining property, shall be deemed a private nuisance.” Me. Rev. Stat. Ann. Tit. 17, §2801. The court noted that the evidence clearly demonstrated that the defendant built the fence with the intent to annoy the plaintiff and interfere with the plaintiffs’ use of their property.
A row of trees can also be a “spite fence.” Unless there is some good reason to plant tall trees on a property line with the knowledge that the trees will block a neighbor’s view, the trees could be deemed to be a malicious spite fence and the trees ordered removed. For example, in Wilson v. Handley, 97 Cal. App. 4th 1301 (2002), the plaintiff built a second story addition to her log cabin. The defendant, a neighbor, then planted a row of evergreen trees parallel with the property line. When the trees became mature in the future, they would block the plaintiff’s mountain view from the second story addition. Because the evidence disclosed that the trees were planted to purposely block the view, they were deemed to be a “spite fence” and a private nuisance in violation of California law. Under California law, any fence or other structure in the nature of a fence (such as trees) that exceeds 10 feet in height and is maliciously erected or maintained for the purpose of annoying the owner or occupant of adjoining property is a private nuisance. See, Cal. Civ. Code §6-10 841.4. See also Vanderpol v. Starr, 194 Cal. App. 4th 385 (2011).
The California case is interesting for the fact that the court determined a “spite fence” existed even though the trees at issue would not obscure the view until some future date, if at all. The court noted that some varieties of trees can grow quickly Normally there can be no claim for an “anticipatory nuisance.” In other words, the law does not recognize an action for a nuisance until the nuisance actually occurs. For example, in Blackwell v. Lucas, No. 2017-CA-01492-COA, 2018 Miss. App. LEXIS 582 (Miss. Ct. App. Nov. 20, 2018), the defendants planted some plants and shrubs in the front yard of their home. Their neighbors, the plaintiffs, sued on the basis that the plants and shrubs caused them “mental pain and suffering.” Their complaint sought damages and preliminary and permanent injunctive relief requiring the removal of the plants and shrubs or to restrict their growth and height so that the plaintiffs’ view of the ocean and surrounding areas was not blocked. The defendants motioned to dismiss the case on the basis that the complaint failed to allege a violation of any legally cognizable right. The trial court dismissed the case.
On appeal, the appellate court noted that the plaintiffs’ only allegation of harm was that, if allowed to grow, the plants and shrubs would obstruct their view across the defendants’ property at some undetermined future date. The plaintiffs claimed that this potential future “harm” gave them a viable cause of action for a “spite fence” or nuisance. The appellate court stated that the plaintiffs had no common law or statutory right to an unobstructed view across their neighbors’ property. Nor did they have a right to dictate the type or placement of the defendants’ shrubs. In support of their claim, the plaintiffs cited the only reported Mississippi case concerning a “spite fence.” In that case, the court ordered the removal of a fourteen-foot-high "spite fence." That court relied on a treatise that defined a "spite fence" as "a structure of no beneficial use to the erecting owner or occupant of the premises but erected or maintained by him solely for the purpose of annoying the owner or occupier of adjoining property.” In this case, however, the appellate court pointed out that because the prior opinion was a 5-5 decision there remained no precedent for a “spite fence” claim under Mississippi law. Moreover, the appellate court declined to recognize a new cause of action for a “spite fence” in a case that did not even involve a traditional fence. The appellate court also pointed out that the plaintiffs’ complaint failed to state a claim for the additional reason that it failed to allege that the “plants and shrubs” actually obstructed their view. The complaint merely asserted that, if allowed to grow, the shrubbery would obstruct their view at some unspecified point in the future. Thus, the appellate court held that the plaintiffs’ complaint failed to state a claim upon which relief could be granted and affirmed the trial court’s decision.
American law generally does not recognize a negative easement for light, air or view. But, if the facts of a situation reveal that light, air or view has been obstructed with the intent to cause harm to an adjoining landowner, then a legal right may be impacted. The obstruction can take the form of a traditional fence, trees and shrubs, or the deliberately improper operation of a farm. If whatever is done, is done with malicious intent, a negative easement may be found to exist.
Wednesday, November 21, 2018
An issue for all motorists, but one of particular interest to motorists using rural roadways is the length of time that a train can block a crossing. In rural areas, there may be few (if any) options for detouring around a blocked crossing.
Many states (and some towns and municipalities) have statutes the denote the maximum length of time that a train can block a crossing. But, can state law regulate the length of time a train blocks a crossing? Is the issue a matter of federal law? That’s the topic of today’s post – train blockage of crossings and how state and federal law deals with the issue.
Many states have statutes that specify the maximum length of time that a train can block a public roadway grade crossing. The state laws vary, but a general rule of thumb is that a blockage cannot exist for more than 20 minutes. There are numerous exceptions, of course, that concern such things as emergencies and when the blockage is a result of something beyond the control of the railroad. In addition, in states that don’t have a state law addressing the issue, there may be restrictions at the local level – cities, towns, villages and municipalities.
Here's a sample of a few state rules on the issue:
In Arizona, if an engineer, conductor or other employee of a railroad permits a locomotive or railcars to be or remain on a crossing of a public highway or over the railway in a manner that obstructs travel over the crossing for longer than 15 minutes is guilty of a class 2 misdemeanor. Ariz. Rev. Stat. §40-852. An exception is provided for an “unavoidable accident.” See also Terranova v. Southern Pacific Transportation Company, 158 Ariz. 125, 761 P.2d 1029 (1988).
Under Iowa law, a ten-minute maximum is the rule. Iowa Code §327G.32. Exceptions are provided when a blockage longer than ten minutes is required for the railroad to comply with signals affecting the safety of the movement of the train; when the train is disabled; or when it is necessary to comply with governmental safety regulations including but not limited to speed ordinances and speed regulations. Interestingly, a railroad employee is not subject to penalty under the provision if they were acting on orders of a supervisor or the railroad in general. In that case, the penalty for violating the law applies to the railroad. The Iowa provision also says that a political subdivision of the state may pass an ordinance dealing with the matter if it for a public safety purpose.
The Indiana law is similar to the Iowa law. In Indiana, public travel cannot be blocked for more than 10 minutes by any train, railroad car, or engine. Indiana Code §8-6-7.5-1. There are exceptions from the 10-minute rule in situations where the train, railroad car or engine cannot be moved by reason of uncontrollable circumstances. In addition, a railroad cannot permit successive train movements to obstruct vehicular traffic at a highway grade crossing until all vehicular traffic that has already been delayed by a train has been allowed at least five minutes to clear. Violations of the law constitutes a “Class C infraction.” The penalty is generally imposed on the railroad corporation.
Nebraska, the home of Union Pacific Railroad, has a very detailed, lengthy statute dealing with the issue. A train obstruction of a public highway, street or alley in any unincorporated town or village in the state is prohibited beyond 10 minutes. Neb. Rev. Stat. §17-225. The penalty for violation is a fine of $10 to $100. In addition, any members of a train crew, yard crew, or engine crew cannot be held personally responsible for any violation if they were acting on orders by their employer. It is the railroad that bears the responsibility to comply with the law. Neb. Rev. Stat. §17-594. Nebraska law also states that at crossings, a train cannot be stored or parked in a manner that obstructs the motoring public’s view of an oncoming train. Neb. Rev. Stat. §74-1323. Violation of the Nebraska provision is coupled with a minimal penalty – Class IV misdemeanor with a maximum fine of $200 for each offense (every day constitutes a separate offense).
Does Federal or State Law Control?
An interesting question involves the extent to which the state laws on public roadway grade crossing blockage laws are valid. Railroads are subject to an interesting mix of federal and state law. Does federal law preempt state law on this issue? That was the question presented in a recent Kansas case.
In State of Kansas v. Burlington Northern Santa Fe Railway Company, No. 118,095, 2018 Kan. App. LEXIS 63 (Kan. Ct. App. Nov. 2, 2018). Burlington Northern Santa Fe Railway (BNSF) operates trains through Bazaar (an unincorporated community) in Chase County, Kansas. At issue were two railroad crossings where the main line and the side lines crossed county and town roads. The side line is used to change crews or let other trains by on the main line. Early one morning, the Chase County Sherriff received a call that a train was blocking both intersections. The Sherriff arrived on scene two hours later and spoke with a BNSF employee. This employee said that he was checking the train but did not state when the train would move. The Sherriff then called BNSF three times. The train remained stopped on both crossings for approximately four hours. The Sherriff issued two citations (one for each engine) under K.S.A. 66-273 for blocking the crossings for four hours and six minutes.
K.S.A. 66-273 prohibits railroad companies and corporations operating a railroad in Kansas from allowing trains to stand upon any public roadway near any incorporated or unincorporated city or town in excess of 10 minutes at any one time without leaving an opening on the roadway of at least 30 feet in width. BNSF moved to dismiss the citation, but the trial court rejected the motion. During the trial, many citizens presented evidence that they could not get to work that day and a service technician could not reach a home that did not have hot water and was having heating problems. BNSF presented train logs for one of the engines. These logs showed that one engine was only stopped in Bazaar for 8 minutes to change crews and was not in Bazaar at 9:54 a.m. The Sheriff later conceded that he might have mistaken the numbers on the engines for the citations. There were no train logs for the other engine. BNSF also stated there could be other alternatives from blocking the crossings but uncoupling the middle of the train would be time consuming and unsafe. The trial court ruled against BNSF and entered a fine of $4,200 plus court costs.
On appeal, BNSF claimed that the Interstate Commerce Commission Termination Act (ICCTA) and Federal Railroad Safety Act (FRSA) preempted Kansas law, and that the evidence presented was not sufficient to prove a violation of Kansas Law. The appellate court agreed, holding that the ICCTA, by its express terms contained in 49 U.S.C. 10501(b), preempted Kansas law. While the appellate court noted that the Kansas statute served an “admirable purpose,” it was too specific in that it applied only to railroad companies rather than the public at large. Also, the statute had more than a remote or incidental effect on railway transportation. As a result, the Kansas law infringed on the Surface Transportation Board’s exclusive jurisdiction to regulate the railways in the United States. The court noted that the Surface Transportation Board was created by the ICCTA and given exclusive jurisdiction over the construction, acquisition, operation, abandonment, or discontinuance of railroad tracks and facilities. In addition, the appellate court noted that the Congress expressly stated that the remedies with respect to regulation of rail transportation set forth in the ICCTA are exclusive and preempt other remedies provided under federal or state law The appellate court did not consider BNSF’s other arguments.
The Kansas case indicates that state law may have to be carefully tailored to apply broadly to roadway obstructions generally, and not have anything more than a slight impact on railway transportation. If those requirements are not satisfied, federal law may control.
Have a blessed Thanksgiving. I will not be posting on Friday this week. The next post will be on Tuesday Nov. 27.
Monday, November 19, 2018
Liability issues abound for farmers and ranchers. Many farmers have a comprehensive farm liability policy to cover potential liability events associated with the farming operation. But, a comprehensive farm liability policy is a hybrid policy that contains both homeowners and commercial insurance elements. That’s because the home is on a part of the same premises where the farm and ranch business is conducted. and live on the same property.
One of the unique aspects of farming and ranching is that it’s not uncommon for a farmer or rancher to conduct some other type of business activity on the farm or ranch premises. That other activity may or may not be related to the business of farming. It is these other activities (such as a road-side stand, corn maize or U-Pick operation) that can raise questions about whether there is insurance coverage for them under the farm’s comprehensive insurance policy. That’s because those policies often exclude “non-farm business pursuits” of the insured.
The scope and application of non-business pursuits of the insured as applied in the context of farming/ranching operations – that’s the focus of today’s post.
The issue is often straightforward for farming operations that don’t conduct a separate business on the premises. The comprehensive liability policy should cover the risks associated with the farming business because of it being tailored to the activities that the insured conducts as part of the farming operation. But, for those that have a smaller farming operation or a hobby farm, the insurance coverage issue can be a big one. Often the insurance coverage for these activities is provided by means of a traditional homeowner’s policy. But, that can mean situations of non-coverage can arise as additional activities occur.
Excluded activities. Homeowner policies exclude business or farming activities. Thus, any activity that is deemed to be “business” or “farming” is excluded from liability or property coverage. That means that liability coverage would need to be broadened by adding an endorsement (subject to the carrier’s guidelines) to the policy that details all of the business or farming activities that are occurring on the premises. Alternatively, a traditional homeowner policy might be able to be modified by adding a “farm liability” endorsement. This additional endorsement would be appropriate when there are farm “hobby” activities on the premises. This endorsement will essentially blend the personal and business coverages by making no distinction between the two general types of activities.
What should be covered? All dwellings on the premises should be covered including all buildings and appurtenant structures, equipment and coverage for livestock. Many homeowner policies will cover a limited amount of animals for personal use such as horses and cows and goats, but if the animal is part of a business activity, a homeowner policy won’t provide coverage. That would mean, for example, that the typical homeowner policy won’t cover liability situations arising from boarding horses whether a fee is charged or not. If a fee is charged, the activity is an excluded business pursuit. If a fee is not charged, coverage may not be available because the horses owned by someone other than the insured.
Hanover American Insurance Company v. White, No. CIV-14-0726-HE, (W.D. Okla. Aug. 3, 2015), is a good illustration of the application of the “business pursuits of the insured.” The insured’s primary business was an aviation-related rental and repair business. He also co-owned an oilfield service company. The premises where the oilfield service company business was conducted was comprised of 150 acres. It was not adjacent to either of the insured’s other properties. The property was fenced, and the insured kept a bull and about 50 head of cattle on the property. The bull was purchased for the purpose of breeding the cows and produce calves. Some of the resulting calf crop was sold and the balance used for team roping. An employee of the oilfield service company cared for the cattle and bought supplies for them by charging the cost to the company’s account.
The bull escaped its enclosure and attacked another person who died as a result of the injuries. The decedent’s estate sued the insured. The insured was covered by a homeowner policy on his residence and a dwelling policy for a dwelling on another property the insured owned. Both policies contained identical language that excluded bodily injury “[a]rising out of or in connection with a ‘business’ engaged in by an ‘insured.’” Both policies also defined “business” to “include…trade, profession or occupation.”
The insurance companies claimed that they had no duty to defend or indemnify the insured. Both companies claimed that the liability event fell within the “business exclusion” of the companies’ respective policies. The insured claimed he wasn’t engaged in a cattle business, but merely a hobby activity and had coverage under the policies. The court disagreed with the insured on the basis that the evidence showed that he engaged in the cattle activity with the intent (at least in part) to make a profit. The court also pointed out that the insured treated the cattle activity as a Schedule F business on his tax returns. That meant that the resulting losses from the cattle activity offset the income of the insured’s wife. Thus, the court was persuaded that the cattle activity was not purely a hobby. It was a business activity not covered by his insurance policies.
In Western National Assurance Company v. Robel, No. 35394-0-III, 2018 Wash. App. LEXIS 2387 (Wash. Ct. App. Oct. 23, 2018), the defendants owned a farm and orchard. The orchard was listed in the area brochure as one of the “U-Pick” orchards. The orchard also sold pre-picked cherries. The plaintiff called the defendants to ensure that they were open before visiting. The plaintiff and her friend arrived at the orchard, and each of them were given a basket to strap on and were directed to the orchard where the 10-foot tall, three-legged ladders were located. While picking cherries on a ladder, the plaintiff ‘s basket filled and caused her to become top-heavy. She lost her balance and fell off the ladder. As a result of the fall, the plaintiff broke her hand and foot, and injured her neck, back and shoulder. The defendants were not at the orchard that day. The plaintiff sued alleging that the defendants, doing business as an orchard, failed to maintain the orchard in a safe manner and failed to properly instruct her on use of the ladder.
The defendants’ insurance company with whom they held a homeowners’ policy defended the suit which was dismissed by the trial court for improper service. The appellate court reversed as to the dismissal and the insurance company brought a declaratory judgment action claiming that the homeowners’ policy did not provide liability coverage for the defendant’s orchard business due to an exclusion for business pursuits of the insured. The trial court agreed and denied coverage under the policy for the plaintiff’s injuries. The appellate court affirmed, finding that the accident arose from a separate business pursuit of the insured that was within the policy exclusion. The appellate court determined that it was immaterial that the defendants did not make much profit from the U-Pick business as a part of their overall farming operation. What mattered, the appellate court determined, was that the defendants sold produce to the public that were invited as business guests to the premises. In addition, the appellate court determined that the use of a ladder was within the scope of the U-Pick business.
The non-farm “business pursuits” exclusion is an important exclusion that rural landowners need to be aware of. It’s a particular issue for smaller, hobby-type operations and those growing or organic or specialty or niche crops. Clearly, each rural/farming enterprise is different. That means that a good comprehensive farm liability policy should be customized to fit each particular situation. Start with the basic coverage and then add on coverage based on your own unique set of facts. Also, give careful thought to the amount of coverage needed. The insurance agent is a key person in making sure that coverage is provided for the needs of the insured. In farm settings, it’s almost always recommended that the insurance agent visit the premises to ensure that the agent has a full understanding of your needs.
Thursday, November 15, 2018
Upon death, the typical process is for someone to be appointed to handle the administration of the decedent’s estate. Once the administrator is appointed, a court-governed process is set in motion that includes providing notice to known and unknown creditors of the estate by means of publishing notice and providing actual notice to known creditors or those that could reasonable be determined to be creditors. Once notice is provided, the creditors have only a few months (usually less than six) to present their claims against the estate for payment.
Does that same timeline on presenting claims apply to the IRS? The ability of the IRS to collect on an unpaid tax claim against a decedent’s estate – that’s the topic of today ‘s post.
As an example, Kansas law specifies that “[E]very petitioner who files a petition for administration or probate of a will shall give notice thereof to creditors, pursuant to an order of the court, and within 10 days after such filing. K.S.A. 59-709(a). The notice is to be “to all persons concerned” and shall state the filing date of the petition for administration or probate of a will. The notice must be published three consecutive weeks and is to be actually be given to “known or reasonably ascertainable creditors” (those discovered by searching reasonably available public records) before expiration of the four-month period for filing claims. K.S.A. 59-709(b). Mere conjectural claims are not entitled to actual notice. Impracticable and extended searches for creditors are not required. If proper notice is not given, the personal representative and the heirs may be liable.
Timeframe For Filing Claims
As noted above, under Kansas law, the creditors have a four-month period to file their claims. That four-month timeframe runs from the time that notice is first published to creditors. However, with respect to the IRS, it has a 10-year collection period that runs from the date it assesses tax. I.R.C. §6502(a)(1). This provision says that the IRS can collect the unpaid tax by either levy or by a court proceeding begun within 10 years after the tax is assessed.
The ability of the IRS to collect unpaid tax from a decedent’s estate and the application of the 10-year statute was at issue in a recent case. In United States v. Estate of Chicorel, No. 17-2321, 2018 U.S. App. LEXIS 30069 (6th Cir. Oct. 25, 2018), the IRS was seeking to collect on an income tax assessment that it had made more than 10 years earlier. Under the facts of the case, the IRS assessed tax of $140,903.52 on September 12, 2005 for the 2002 tax year. The tax didn’t get paid before the decedent died in the fall of 2006. In early 2007, the decedent’s nephew was appointed the estate's personal representative, and he published a notice to creditors (in accordance with Michigan law) of the four-month deadline for presenting claims. However, he did not mail the notice to the IRS even though he knew of the unpaid tax liability. In early 2009, the IRS filed a proof of claim in the ongoing probate proceeding. The nephew didn’t respond, and the IRS filed a collections proceeding in early 2016 attempting to reduce the 2005 tax assessment to judgment. The estate claimed that the claim was filed too late, but the trial court held that the filing in 2009 of the proof of claim was a “court proceeding” as required by I.R.C. §6502(a)(1). Thus, because it was filed within 10 years from the date the tax was assessed, the IRS could collect the tax outside the 10-year window.
On appeal, the appellate court affirmed. The appellate court noted that whether a proof of claim is a "proceeding in court" is a question of federal law that turns on the nature, function, and effect of the proof of claim under state law. See United States v. Silverman, 621 F.2d 961 (9th Cir. 1980); United States v. Saxe, 261 F.2d 316 (1st Cir. 1958). That meant that the appellate court had to look at how Michigan treated the filing of a proof of claim in a probate proceeding and whether it qualified as a “court proceeding” under I.R.C. §6502(a). The appellate court noted that the nature, function, and effect of a proof of claim in Michigan had significant legal consequences for the creditor, the estate, and for Michigan law generally. Because of this, the appellate court held that the filing of the proof of claim qualified as a proceeding in court under I.R.C. §6502(a). The appellate court noted that the Michigan probate code specifies that "[f]or purposes of a statute of limitations, the proper presentation of a claim . . . is equivalent to commencement of a proceeding on the claim." Mich. Comp. Laws. §700.3802(3). Thus, the filing of the proof of claim not only tolled the statute of limitations, it constituted a “proceeding” that required the decedent’s estate to take action – either providing notice that the claim is disallowed or allowed. The filing of the proof of claim started a process whereby the claim would eventually be dealt with one way or the other. The appellate court also noted that the executor failed to give actual notice to the IRS to present its claim because it was a known creditor of the estate. That failure excused the IRS from filing the claim within the four-month window after notice was first published and extended that deadline to three years from the date of the decedent’s death. Thus, the IRS had timely filed its proof of claim.
The appellate court also determined that the filing of the proof of claim was timely under I.R.C. §6502(a). That statute, the court held, is satisfied once the government started any timely proceeding in court. Because that requirement was satisfied, the IRS has an unlimited amount of time to enforce the assessed tax. The appellate court noted that I.R.C. §6502(a) focuses on the ability of the IRS to collect assessments. While it does not permit the IRS to let an assessed tax lie dormant and then attempt to collect the tax way at some far off future date, once a timely collection action has been filed, the IRS can collect the tax beyond the 10-year timeframe. See United States v. Weintraub, 613 F.2d 612 (6th Cir. 1979). The appellate court noted that the IRS filed its proof of claim in 2009 which was well within the 10-year limitations period for the 2005 assessment. That filing constituted a “proceeding in court” under I.R.C. §6502(a) in satisfaction of that provision’s 10-year requirement. There was no further time bar on the ability of the IRS to collect. The is not requirement that a “judgment” be reached in the proceeding within that 10-year time frame, and the ability of the IRS to collect did not expire until the tax liability is satisfied or becomes unenforceable.
While in just about every situation a creditor must present its claim against a decedent’s estate within a short time-frame post-death, the rules governing the ability of the IRS to collect on an unpaid tax liability from a decedent’s estate are different. Once the IRS timely files its claim in the probate proceeding, it remains a creditor until the tax is paid. It also may not be barred by state law statute of limitations if it doesn’t timely file a claim against an estate. See, Board of Comm'rs of Jackson County v. United States, 308 US 343 (1939); United States v. Summerlin, 310 US 414 (1940) .
Is the executor personally liable for the tax? Perhaps. But, I.R.C. §6905(a) does provide a procedure for the executor to escape personal liability if doing so would not impact the liability of the decedent’s estate.
Just another one of the quirks about tax law and the IRS. It’s helpful to know. As Benjamin Franklin stated in 1789, “In this world nothing can be said to be certain, except death and taxes.”
Tuesday, November 13, 2018
My recent post on like-kind exchanges and the definition of real estate received a lot of attention, positive comments and questions. Several of those questions involved the issue of whether real estate that is held in a trust can qualify for like-kind exchange treatment. It’s an important question, particularly because the Tax Cuts and Job Act makes like-kind exchange treatment only applicable to real estate trades after 2017.
Whether real estate held in trust can qualify for like-kind exchange treatment – that’s the topic of today’s post.
Real Property – What Is It?
As noted above, real estate remains eligible property for a like-kind exchange under I.R.C. §1031. Often, state law determines whether an item of property is real property. For instance, in Oregon Lumber Co. v. Comr., 20 T.C. 192 (1953), the court held that the right to cut timber was not an interest in real property under state (Oregon) law. Thus, the exchange of land for the right to cut timber on national forest land was not a like-kind exchange under I.R.C. §1031. Also, in Priv. Ltr. Rul. 200424001 (Dec. 8, 2003), the IRS determined that components of a railroad track that are assembled and attached to the land and are real estate under state law are not like-kind to unassembled and unattached components because the latter is considered personal property under state law. But, where a water right under state law (Kansas) constitutes a perpetual interest in real property, the trade of the water right for a fee simple interest in farmland does qualify for like-kind exchange treatment. Priv. Ltr. Rul. 200404044 (Oct. 23, 2003). In addition, an agricultural conservation easement, if it is an interest in real property under state law, can be exchanged for like-kind real estate and qualify for deferral of tax under I.R.C. §1031. Priv. Ltr. Rul. 9851039 (Sept. 15, 1998); Priv. Ltr. Rul. 200201007 (Oct. 2, 2001).
But, state law doesn’t always determine the outcome. Sometimes state law may treat a particular interest as a real property interest, but the interest may be a “chose in action” (rights associated with personal property) for Federal income tax purposes. Thus, rights under a sales contract that are exchanged for real property may not qualify as a like-kind exchange. See, e.g., Coupe v. Comr., 52 T.C. 394 (1969).
The Treasury Regulations specify that a land lease of 30 years or more is the equivalent of an interest in real property. Treas. Reg. §1.1031(a)-1(c). In addition, real property involved in an exchange must be located in the United States (the 50 states and D.C.) to qualify for non-recognition treatment. I.R.C. §1031(h); but also see I.R.C. §932 and Priv. Ltr. Rul. 200040017 (Jun. 30, 2000).
What About Trusts?
Trusts are a popular part of many farm and ranch (and other) estate plans. If farmland or ranchland is contained in a trust, is it still eligible to be exchanged for other real property and have the gain (or loss) on the transaction deferred under I.R.C. §1031? If so, that means that placing land in a trust for estate planning (or other) reasons doesn’t eliminate the favorable tax consequences of I.R.C. §1031.
1992 IRS ruling. There is some guidance on the issue of whether real estate contained in a trust is eligible for I.R.C. §1031 treatment. In 1992, the IRS issued a Revenue Ruling taking the position that an interest in an Illinois Land Trust was real property that could be exchanged for like-kind real estate. Rev. Rul. 92-105, 1992-2 C.B. 204. While a beneficiary’s interest in a land trust was deemed to be personal property under state (IL) law, that characterization didn’t control the outcome. The IRS looked at the facts of the particular situation and noted that the trustee was only acting at the discretion of the taxpayer (beneficiary). The trustee merely held title and could only potentially transfer that title. Thus, the trust was an agency relationship between the trustee and beneficiary involving the holding and transferring of the title to the real estate contained in the trust. The taxpayer/beneficiary retained the right to manage and control the trustee, and remained the direct owner of the property for tax purposes. It was the beneficiary that remained obligated to pay the taxes and other liabilities associated with the trust property, and it was the beneficiary that had the exclusive right to the trust property’s earnings and profits. Based on those facts, the IRS determined that the beneficiary’s interest in the trust was an interest in real property that could be exchanged for other real property and qualify for deferral of gain (or loss) via I.R.C. §1031.
The trust and the relationship of the parties in the 1992 ruling was not determined to be a partnership. If the IRS had determined that a partnership was involved, that would have meant that the beneficiary’s interest in the real estate in the trust would not have qualified for like-kind exchange treatment – partnership interests are not eligible. Important to that point, only one beneficiary was involved under the facts of the ruling. With multiple beneficiaries, it may be easier for the IRS to asset that a partnership exists and deny I.R.C. §1031 eligibility.
Based on Rev. Rul. 92-105, if a trust (or similar arrangement created under state law) is merely an investment vehicle, it can qualify as like-kind to real property under I.R.C. §1031. That’s certainly the case for a trust if the trustee has title to the real property in the trust; the beneficiary has the exclusive right to direct or control the trustee in dealing with title to the property; and the beneficiary has the exclusive control of the property’s management as well as the obligation to pay any taxes and other liabilities that relate to the property. When those factors are present, an exchange transaction actually involves the exchange of the underlying trust property rather than an exchange of a certificate of trust beneficial interest, and the gain or loss on the transaction can be eligible for deferral under I.R.C. §1031.
2004 IRS ruling. Twelve years after Rev. Rul. 92-105, the IRS issued another revenue ruling on the issue. Rev. Rul. 2004-86, 2004-2 C.B. 191 involved a Delaware Statutory Trust (DST). A DST is a form of business trust. Under the facts of the ruling, the trustee’s powers were limited to only collecting and distributing income. As such, the DST was merely an investment trust and its interests could be exchanged for real property in an I.R.C. §1031 transaction. However, with more retained powers in the trustee, the IRS said that the trust would be a business trust rather than an investment trust and would not qualify for like-kind treatment. Consequently, Rev. Rul. 2004-86 is quite limited. But, if all of the interests in the trust are of a single class that represent undivided beneficial interests of the trust and the trustee cannot vary the trust’s investments, the trust will be an investment trust and its assets can be exchanged for real property with any gain qualifying for deferral under I.R.C. §1031. On the other hand, if the trustee has greater discretion with respect to the trust property, those additional powers could cause disqualification from I.R.C. §1031 treatment. Those additional powers could include, for instance, the power to dispose of the real property in the trust and acquire new property, the power to renegotiate leases on the trust property, or approve more than minor modifications or improvements to the property. If those powers are present, the IRS could take the position that the trust constitutes a business entity not eligible for I.R.C. §1031 treatment.
An additional important aspect of the 2004 Rev. Rul. is that the IRS at least impliedly classified the DST as a grantor trust. Thus, real estate contained in a grantor trust could be exchanged for interests in a grantor trust containing real property and the transaction would qualify for deferral treatment under I.R.C. §1031. That has important estate planning implications. A revocable living trust is a grantor trust. Such trusts are a part of many estate plans. Irrevocable trusts are also a popular estate planning tool. An irrevocable trust can be a grantor trust if the grantor retains, for example, the “power to control beneficial enjoyment.” I.R.C. §674.
For real property contained in trust, if the trustee’s powers are limited, the real property can be exchanged for other real property and qualify for gain (or loss) deferral under I.R.C. §1031. Land contained in a grantor trust is deemed to be owned by the individual grantor and remains eligible for I.R.C. §1031 treatment. For land contained in a non-grantor trust, the language of the trust is critical. For non-grantor trusts, the trust language must place sufficient limitations on the trustee’s powers to allow the trust beneficiary to receive like-kind exchange treatment under I.R.C. §1031.
Friday, November 9, 2018
Legal developments impacting rural landowners, producers and agribusinesses continue to occur. The same can be said for tax developments that impact practitioners and their client base. It’s a never-ending stream.
In today’s post, I examine just a few of the recent developments from the courts of relevance.
Debtor Can Convert Chapter 12 Case to Chapter 11
Can a Chapter 12 bankruptcy case be converted to Chapter 11? That was the issue in In re Cardwell, No. 17-50307-rlj12, 2018 Bankr. LEXIS 3089 (Bankr. N.D. Tex. Oct. 3, 2018). The debtor, an elderly widowed woman, owned three tracts of farmland that she leased out for farming purposes. The tracts served as collateral for loans taken out by her children and grandchildren. The debtor sued a bank and the spouse of a granddaughter for “improprieties on the loans and liens.” The debtor filed Chapter 12, but the bank moved to dismiss the case on the basis that the debtor was not a ‘family farmer.” The debtor then moved to convert the case to Chapter 11. The bank objected, claiming that a Chapter 12 case cannot be converted to a Chapter 11.
While the court noted that there is some authority for that proposition, the court also noted that there is no explicit statutory language that bars a Chapter 12 from being converted to a Chapter 11 and that the courts are split on the issue. Ultimately, the court concluded that 11 U.S.C. §1208(e) allowed for conversion if the proceeding was in good faith and conversion would not be inequitable or prejudicial to creditors. The court also noted that if it dismissed the debtor’s Chapter 12 case, the debtor could simply refile the matter as a Chapter 11 case. The court saw no point in requiring that procedural step as there was no explicit statutory language requiring dismissal and refiling. The court also noted that upon conversion the automatic stay would remain in place, and that the debtor would actually have a more difficult time getting her reorganization plan confirmed as part of a Chapter 11 case as compared to a Chapter 12 case.
Federal Law Preempts Kansas Train Roadway Blockage Law
Burlington Northern Santa Fe Railway (BNSF) operates trains through the town of Bazaar in Chase County, Kansas. At issue State of Kansas v. Burlington Northern Santa Fe Railway Company, No. 118,095, 2018 Kan. App. LEXIS 63 (Kan. Ct. App. Nov. 2, 2018), were two railroad crossings where the main line and the side tracks crossed county and town roads. The side track is used to change crews or let other trains by on the main line. Early one morning, the Chase County Sheriff received a call that a train was blocking both intersections. The Sheriff arrived on scene two hours later and spoke with a BNSF employee. This employee said that he was checking the train but did not state when the train would move. The Sheriff then called BNSF three times. The train remained stopped on both crossings for approximately four hours. The Sheriff issued two citations (one for each engine) under K.S.A. 66-273 for blocking the crossings for four hours and six minutes. K.S.A. 66-273 prohibits railroad companies and corporations operating a railroad in Kansas from allowing trains to stand upon any public roadway near any incorporated or unincorporated city or town in excess of 10 minutes at any one time without leaving an opening on the roadway of at least 30 feet in width. BNSF moved to dismiss the citation, but the trial court rejected the motion.
During the trial, many citizens presented evidence that they could not get to work that day, and a service technician could not reach a home that did not have hot water and was having heating problems. BNSF presented train logs for one of the engines. These logs showed that one engine was stopped in Bazaar for only 8 minutes to change crews and was not in Bazaar at 9:54 a.m. The Sheriff later conceded that he might have been mistaken about the numbers on the engines for the citations. There were no train logs for the other engine. BNSF also stated there could be other alternatives from blocking the crossings but uncoupling the middle of the train would be time consuming and unsafe.
The trial court ruled against BNSF and entered a fine of $4,200 plus court costs. On appeal, BNSF claimed that the Interstate Commerce Commission Termination Act (ICCTA) and Federal Railroad Safety Act (FRSA) preempted Kansas law, and that the evidence presented was not sufficient to prove a violation of Kansas law. The appellate court agreed, holding that the ICCTA, by its express terms contained in 49 U.S.C. 10501(b), preempted Kansas law. While the appellate court noted that the Kansas statute served an “admirable purpose,” it was too specific in that it applied only to railroad companies rather than the public at large. Also, the statute had more than a remote or incidental effect on railway transportation. As a result, the Kansas law infringed on the Surface Transportation Board’s exclusive jurisdiction to regulate the railways in the United States. The appellate court noted that the Surface Transportation Board was created by the ICCTA and given exclusive jurisdiction over the construction, acquisition, operation, abandonment, or discontinuance of railroad tracks and facilities. In addition, the appellate court noted that the Congress expressly stated that the remedies with respect to regulation of rail transportation set forth in the ICCTA are exclusive and preempt other remedies provided under federal or state law. The appellate court did not consider BNSF’s other arguments.
Groundwater Is Not a “Point Source” of Pollution Under the CWA
The defendant in Tennessee Clean Water Network v. Tennessee Valley Authority, No. 17-6155, 2018 U.S. App. LEXIS 27237 (6th Cir. Sept. 24, 2018), is a utility that burns coal to produce energy. It also produces coal ash as a byproduct. The coal ash is discharged into man-made ponds. The plaintiffs, environmental activist groups, claimed that the chemicals from the coal ash in the ponds leaked into surrounding groundwater where it was then carried to a nearby lake that was subject to regulation under the Clean Water Act (CWA). The plaintiffs claimed that the contamination of the lake without a discharge permit violated the CWA and the Resource Conservation and Recovery Act (RCRA).
The trial court had dismissed the RCRA claim, but the appellate court reversed that determination and remanded the case on that issue. On the CWA claim, the trial court ruled as a matter of law that the CWA applies to discharges of pollutants from a point source through hydrologically connected groundwater to navigable waters where the connection is "direct, immediate, and can generally be traced." The trial court held that the defendant’s facility was a point source because it "channel[s] the flow of pollutants . . . by forming a discrete, unlined concentration of coal ash," and that the Complex is also a point source because it is "a series of discernible, confined, and discrete ponds that receive wastewater, treat that wastewater, and ultimately convey it to the Cumberland River." The trial court also determined that the defendant’s facility and the ponds were hydrologically connected to the Cumberland River by groundwater. As for the defendant’s facility, the trial court held that "[f]aced with an impoundment that has leaked in the past and no evidence of any reason that it would have stopped leaking, the Court has no choice but to conclude that the [defendant’s facility] has continued to and will continue to leak coal ash waste into the Cumberland River, through rainwater vertically penetrating the Site, groundwater laterally penetrating the Site, or both." The trial court determined that the physical properties of the terrain made the area “prone to the continued development of ever newer sinkholes or other karst features." Thus, based on the contaminants flowing from the ponds, the court found defendant to be in violation of the CWA. The trial court also determined that the leakage was in violation of the defendant “removed-substances” and “sanitary-sewer” overflow provisions. The trial court ordered the defendant to "fully excavate" the coal ash in the ponds (13.8 million cubic yards in total) and relocate it to a lined facility.
On further review, the appellate court reversed. The appellate court held that the CWA does not apply to point source pollution that reaches surface water by means of groundwater movement. The appellate court rejected the plaintiffs’ assertion that mere groundwater is equivalent to a discernable point source through which pollutants travel to a CWA-regulated body of water. The appellate court noted that, to constitute a “conveyance” of groundwater governed by the CWA, the conveyance must be discernible, confined and discrete. While groundwater may constitute a conveyance, the appellate court reasoned that it is neither discernible, confined, nor discrete. Rather, the court noted that groundwater is a “diffuse” medium that “travels in all directions, guided only by the general pull of gravity.” In addition, the appellate court noted that the CWA regulates only “the discharge of pollutants ‘to navigable waters from any point source.’” In so holding, the court rejected the holdings in Hawai’i Wildlife Fund v. County of Maui, 881 F.3d 754 (9th Cir. 2018) and Upstate Forever, et al. v. Kinder Morgan Energy Partners, LP, et al., 887 F.3d 637 (4th Cir. 2018).
Cash Gifts to Pastor Constituted Taxable Income
In Felton v. Comr., T.C. Memo. 2018-168, the petitioner was the pastor of a church and the head of various church related ministries in the U.S. and abroad, got behind on his tax filings and IRS audited years 2008 and 2009. While most issues were resolved, the IRS took the position that cash and checks that parishioners put in blue envelopes were taxable income to the petitioner rather than gifts. The amounts the petitioner received in blue envelopes were $258,001 in 2008 and $234,826 in 2009. There was no question that the church was run in a businesslike manner. While the church board served in a mere advisory role, the petitioner did follow church bylaws and never overrode the board on business matters. As for contributions to the church, donated funds were allocated based on an envelope system with white envelopes used for tithes and offerings for the church. The white envelopes also included a line marked “pastoral” which would be given directly to the petitioner. The amounts in white envelopes were tracked and annual giving statements provided for those amounts.
The petitioner reported as income the amounts provided in white envelopes that were designated as “pastoral.” Amount in gold envelopes were used for special programs and retreats, and were included in a donor’s annual giving statement. Amounts in blue envelopes (which were given out when asked for) were treated as pastoral gifts and the amounts given in blue envelopes were not included in the donor’s annual giving statement and the donor did not receive any tax deduction for the gifted amounts. Likewise, the petitioner did not include the amounts given in blue envelopes in income. The IRS took the position that the amounts given by means of the blue envelopes were taxable income to the petitioner. The Tax Court agreed, noting that the petitioner was not retiring or disabled. The court also noted that the petitioner received a non-taxable parsonage allowance of $78,000 and received only $40,000 in white envelope donations. The court also upheld the imposition of a penalty because the petitioner, who self-prepared his returns, made no attempt to determine the proper tax reporting of the donations.
The developments keep rolling in. There will be more to write about in a subsequent post.
Wednesday, November 7, 2018
Section 404 of the Clean Water Act (CWA) makes illegal the discharging of dredge or fill material into the “navigable waters of the United States” (WOTUS) without obtaining a permit from the Secretary of the Army acting through the Corps of Engineers (COE). 33 U.S.C. §§1311(a); 1362(6),(12). The definition of what a WOTUS has been confusing and controversial in recent years. How is a wetland that could be a WOTUS delineated? What force do definitions contained in a COE manual have? What about supplements?
How the government defines a “WOTUS” – that’s the focus of today’s post.
The regulatory definition of a “wetland” has changed over the years. In its 1987 Manual for delineating wetlands, before the COE may assert jurisdiction over property, it must find the area satisfies the three wetland criteria of hydric soil, predominance of hydrophytic vegetation, and wetland hydrology (soil saturation/inundation). Wetland hydrology under the 1987 Manual requires either the appropriate inundation during the growing season or the presence of a primary indicator. Table 5 of the 1987 Manual indicates a nontidal area is not considered to evidence wetland hydrology unless the soil is seasonally inundated or saturated for 12.5 percent to 25 percent of the growing season. A “growing season” is defined as a season in which soil temperature at 19.7 inches below the surface is above 41 degrees Fahrenheit.
The 1987 Manual lists six field hydrologic indicators, in order of decreasing reliability, as evidence that inundation and/or soil saturation has occurred: (1) visual observation of inundation; (2) visual observation of soil saturation; (3) watermarks; (4) drift lines; (5) sediment deposits; and (6) drainage patterns within wetlands.
In 1989, the COE adopted a new manual. The 1989 Manual superseded the 1987 Manual. The delineation procedures contained in the 1989 manual were less stringent. Thus, it became more likely that the COE could determine that a particular tract contained a regulable wetland. This change in delineation techniques caught the attention of the Congress which barred the use of the 1989 Manual via the 1992 Budget Act. Pub. L. No. 102-104, 105 Stat. 510 (Aug. 17, 1991). Specifically, the 1992 Budget Act prohibited the use of funds to delineate wetlands under the 1989 Manual "or any subsequent manual not adopted in accordance with the requirements for notice and public comment of the rulemaking process of the Administrative Procedure Act." The 1992 Budget Act also required the Corps to use the 1987 Manual to delineate any wetlands in ongoing enforcement actions or permit application reviews. In the 1993 Budget Act, the Congress again addressed the issue by stating that, “None of the funds in this Act shall be used to identify or delineate any land as a "water of the United States" under the Federal Manual for Identifying and Delineating Jurisdictional Wetlands that was adopted in January 1989 or any subsequent manual adopted without notice and public comment. Furthermore, the Corps of Engineers will continue to use the Corps of Engineers 1987 Manual, as it has since August 17, 1991, until a final wetlands delineation manual is adopted.” Thus, it was clear that Congress mandated that the COE continue to use the 1987 Manual to delineate wetlands unless and until the COE utilized the formal rulemaking process to change the delineation procedure.
While the Congress mandated the use of the 1987 Manual to delineate wetlands, it also appropriated funds to the U.S. Environmental Protection Agency (EPA) to contract with the National Academy of Sciences for a review and analysis of wetland regulation at the federal level. See Department of Veterans Affairs and Housing and Urban Development and Independent Agencies Appropriations Act of 1993, Pub. L. 102-389, 106 Stat. 1571 (Oct. 6, 1992); H.R. Rep. No. 102-710, at 51 (1992); H.R. Conf. Rep. No. 102-902 at 41. This resulted in a report being published in 1995 containing a suggestion that the 1987 Manual either eliminate the requirement of a “growing season” approach to wetland hydrology or move to a region-specific set of criteria for delineating wetlands. Consequently, the COE began issuing regional “supplements” to the 1987 Manual that provided criteria for wetland delineation that varied across the country. For instance, in the COE’s 2007 Alaska Supplement, the COE eliminated the measure of soil temperature contained in the 1987 Manual and replaced it with “vegetation green-up, growth, and maintenance as an indicator of biological activity occurring both above and below ground.” The 2007 Supplement was updated in 2008.
The 1987 Manual and the budget bills and COE region-specific Supplements were the issue of a recent case. In Tin Cup, LLC v. United States Army Corps of Engineers, No. 17-35889, 2018 U.S. App. LEXIS 27085 (9th Cir. Sept. 21, 2018), the plaintiff was a closely-held family pipe fabrication company in Alaska that sought to relocate its business for expansion purposes. The plaintiff found a suitable location (a 455-acre tract in North Pole) where it would need to lay gravel and construct buildings as well as a railroad spur. Because gravel is contained within the regulatory definition of “pollutant” under the CWA and because the tract was purportedly a “wetland,” the plaintiff had to obtain a discharge permit so that it could place gravel fill on the property before starting construction.
The plaintiff received a permit in 2004 and, pursuant to that permit, cleared about 130 acres from the site. In 2008, the plaintiff submitted another permit application to place gravel fill on the site. The COE issued a new jurisdictional determination in 2010, concluding that wetlands were present on 351 acres, including about 200 acres of permafrost – frozen soil. The COE granted the plaintiff a discharge permit to place gravel fill on 118 acres, but included mitigation conditions that the plaintiff objected to. The plaintiff sued on the basis that the COE’s delineation of permafrost as a wetland was improper and, thus, a discharge permit was not necessary.
The COE delineated the permafrost on the tract as wetland based on its 2008 Alaska Supplement. U.S. Army Corps of Engineers, Regional Supplement to the Corps of Engineers Wetland Delineation Manual: Alaska Region (Version 2.0) (Sept. 2007). However, the COE’s 1987 Manual specifically excludes permafrost from the definition of a wetland. The plaintiff argued that the Congress had instructed the COE to continue to use the wetland delineation standards in the 1987 Manual until the COE adopted a “final wetland delineation manual” as set forth in the 1992 and 1993 Budget Acts, as noted above. Thus, because permafrost does not have the required “growing season” (it never reached 41 degrees Fahrenheit at a soil depth of 19.7 inches) it cannot be a wetland. The plaintiff pointed out that by virtue of the issuance of regional supplements to the 1987 Manual, the COE had expanded its jurisdiction over private property by modifying the definition of a “wetland.” Key to the plaintiff’s argument was the point that the Supplement was not a new manual that had been developed in accordance with the formal rulemaking process (e.g., notice, comment, and public hearing). It also was never submitted to the Congress and the Government Accountability Office which, the plaintiff noted, the Congressional Review Act requires before any federal governmental agency rule can become effective. 5 U.S.C. Ch. 8, Pub. L. No. 104-121, §201.
The trial court ruled against the plaintiff, holding that the COE could rely on the 2008 Supplement when delineating a wetland and determining its jurisdiction. The trial court determined that the Budget Acts have no force beyond the funds that they appropriate. That meant that the COE could delineate wetlands in accordance in whatever manner it determined – the 1987 Manual or any subsequent Manual or supplemental guidance that it issued.
On appeal, the appellate court affirmed, holding that the 1993 Budget Act did not require the COE to continue using the 1987 Manual to delineate wetlands. The appellate court stated that there is a “very strong presumption” that if an appropriations act changes substantive law, it does so only for the fiscal year for which the bill is passed” unless there is a clear statement of futurity. Because the 1993 Budget Act contained no such statement, the Court held that the requirement for use of the definition of a growing season in accordance with the 1987 Manual expired at the end of the 1993 fiscal year.
One of the appellate judges, while concurring with the decision that the lower court did not err in granting summary judgment to the COE, disagreed that the 1993 Budget Act didn’t apply beyond the 1993 fiscal year. This judge noted that the Congress, in the 1993 Budget Act, specifically directed the COE to continue to use the 1987 Manual “until” it adopted a final wetlands delineation manual. According to this judge, that was a sufficient Congressional directive of futurity that made the directive applicable beyond the Federal Government’s 1993 fiscal year.
The definition of a “wetland” and “WOTUS” is confusing and controversial. The Ninth Circuit’s holding that the COE can conclude that frozen soil is a navigable water will not diminish that controversy. The issue of the application of congressional budget act provisions is also one that there is not agreement upon within the federal appellate courts. Perhaps the U.S. Supreme Court will hear the case.
As for me, I am going to read my copy of Alice in Wonderland. It might make more sense than concluding that gravel is pollution and frozen dirt is water and when the Congress says not to do something, you can.
Monday, November 5, 2018
During the farm debt crisis of the 1980s, Chapter 12 bankruptcy was enacted to provide a means for “family farmers” to receive debt relief in the context of more favorable bankruptcy reorganization rules than would otherwise apply. Now that the farm sector has been going through several down economic years, the use of Chapter 12 has increased again.
Requirements must be satisfied to qualify for Chapter 12 relief. Once that occurs, the farmer- debtor can take advantage of numerous favorable provisions. One of those is the “tools-of-the-trade” exemption. A farm debtor can keep assets exempt from creditors that are needed continue the farming operation.
The tools-of-the-trade exemption in the context of Chapter 12 bankruptcy. That’s the topic of today’s post.
Chapter 12 Eligibility
To be eligible for Chapter 12 bankruptcy, a debtor must be a “family farmer” or a “family fisherman” with “regular annual income.” The term “farming operation” includes farming, tillage of the soil, dairy farming, ranching, production or raising of crops, poultry, or livestock, and production of poultry or livestock products in an unmanufactured state. 11 U.S.C. §101(21). A “family farmer” is defined as an individual or individual and spouse who earned more than 50 percent of their gross income from farming either for the taxable year preceding the year of filing or during the second and third tax years preceding filing, and whose aggregate debts do not exceed $4,153,150 (as of April, 2016). In addition, more than 80 percent of the debt must be debt from a farming operation that the debtor owns or operates.
The U.S. legal system has a long history of allowing debtors to hold specified items of property exempt from creditors (unless the exemption is waived). This, in effect, gives debtors a “head start” in becoming reestablished after suffering economic reverses. Typically, one of the largest and most important exemptions is for the homestead.
Initially even the exempt property is included in the debtor's estate in bankruptcy but the exempt assets are soon returned to the debtor. Only nonexempt property is used to pay the creditors.
In agricultural bankruptcies, one of the more important exemptions listed above is for “tools-of-the-trade.” 11 U.S.C. §522(f) permits the avoidance of non-possessory, non-PMSIs in “implements, professional books, or tools of the trade of the debtor or the trade of a dependent of the debtor” when the security interest impairs an exemption to which the debtor would have been entitled but for the security interest.
Conceivably, many farm assets could qualify as a tool-of-the-trade. For example, some courts have held that livestock held for breeding purposes (In re Heape, 886 F.2d 280 (10th Cir. 1989). large items of farm equipment (In re LaFond, 791 F.2d 623 (8th Cir. 1986), and draft horses (In re Stewart, 110 B.R. 11 (Bankr. D. Idaho 1989) are tools of the debtor's trade. Generally, courts focus on the functional use of an asset in the debtor's business in determining whether the asset is a tool of the debtor's trade.
The debtor must be actively engaged in a farming business to exempt farm assets as tools of the trade. For example, in In re Johnson, 230 B.R. 608 (Bankr. 8th Cir. 1999), the debtor owned a 73-acre rural residence, but had not farmed in past two years and was employed full-time off of the farm. The court held that the farm machinery was not tools of debtor’s trade because the debtor not actively engaged in farming. In any event, to be considered as an exempt tool of the debtor’s trade, the debtor must have a reasonable prospect of continuing in or returning to the farming business. For instance, in In re Henke, 294 B.R. 105 (Bankr. D. N.D. 2003), farm equipment was not exempt as a tool of the trade where the debtor had no reasonable prospect of returning to the farming business.
A recent Kansas Chapter 12 case is a good illustration of how courts analyze the applicability of the tools-of-the-trade exemption. In In re Rudolph, No. 18-40423, 2018 Bankr. LEXIS 3328 (Bankr. D. Kan. Oct. 30, 2018), the debtors (a married couple) significantly reduced the scale of their farming operation before filing Chapter 12. Upon filing Chapter 12, the debtors claimed the Kansas exemption for tools of the trade contained in Kan. Stat. Ann. §60-2304(e). The debtors’ lender (a bank) objected to the exemption on the basis that the debtors had so significantly reduced their farming operations that they were no longer “farmers” as their primary occupation, or that the debtors were only entitled to a percentage of the exemption.
The husband debtor had farmed since 1948 and his wife began working exclusively on the farm in 2007. The bank agreed that if the husband was entitled to the exemption his wife was also. The debtors’ homestead consisted of 17 acres, and the debtors used a portion of it to raise a forage crop for livestock and another portion was used as a hay meadow for livestock grazing. The husband debtor was also the beneficiary of three tracts of land held in trusts established by his parents consisting of almost 500 acres that were a mixture of row crop, hay meadow, pasture and CRP ground. The debtor, via the trust instrument, was responsible for managing those properties.
The bank financed the debtors’ farming operations and when the loans matured in late 2017 the bank sought payment. The debtors’ proposed to pay the loan by retiring from row crop farming and generating funds from the sale of certain farm equipment. At the time of filing, the debtors were no longer row crop farming but were continuing to care for cattle on the trust properties and were managing the CRP acres. Some of the trust properties were rented out, with the debtors maintaining fences and providing nutrients and care for the tenants’ cattle. The debtors also planted fall crops to feed to their own cattle and horses. The debtors inspected the trust lands twice weekly and controlled weeds on the CRP ground and maintained brush control. Their proposed reorganization plan estimated their monthly net farm income as $978.98 and they projected their annual gross farm income to be $21,364 with $20,800 consisting of farm rental income. The debtors testified to the value of the items of personal property that they were claiming as tools of the trade, and the total claimed value did not exceed the statutorily allowed amount.
The court noted that the debtors retained only those farming assets that were necessary to the continuation of their reduced-scale farming operation and turned over other assets to the bank. The debtors also proposed to retain four non-exempt tractors by paying the bank their value in ten semi-annual installments, with interest. The court noted that eligibility for the exemption was to be determined as of the date of filing. As the court pointed out, that’s different than a debtor being eligible for Chapter 12 – which is based on debt and income in the year preceding filing (or the second and third years back). The court also pointed out that the only issues for consideration as to eligibility for the exemption was whether the debtors were engaged in the farming business, and whether the claimed exempt items were regularly and reasonably necessary in carrying on that business.
While the court pointed out that the debtors were no longer engaged in planting and harvesting crops, as of the date the Chapter 12 petition was filed, the court determined that the debtors were engaged in ranching and other farming activities such as cattle grazing, harvesting hay and planting forage crops to feed cattle and horses. The court noted that the debtors also maintained the farmland in the trusts and managed the 3-5 acres of CRP ground. The court specifically determined that while the debtors did not have most of their income come from farming, the tools of the trade exemption does not require that farming be the exclusive or sole means generating income. The court also concluded that the exemption does not require the tools to be used on land the debtor farms for himself (crop/livestock share leases are permissible as is managing CRP ground) or produce something for sale.
The court also rejected the bank’s argument that the debtors couldn’t claim the exemption because they had quit farming as of the time they filed for Chapter 12 as contrary to the evidence. The evidence showed that the debtors had at least temporarily retired from crop farming, but not from ranching and caring for agricultural land as indicated by the retention of some equipment essential to continuing the ranching and ag land maintenance activities. In addition, the debtors’ proposed budget that showed only social security benefits and retirement benefits along with land rent was consistent with the debtors’ testimony that they were reducing their farming activities. The court determined that the debtors were still engaged in the trade or business of farming as of the petition date and were entitled to claim the tools-of-the-trade exemption. However, the court determined that five of the claimed horses were not eligible for the exemption as nonessential to the continuation of the debtors’ farming activities. The court also stated that the bank’s objection to the valuation of the exempt assets would be determined in a separate proceeding unless the parties came to an agreement.
Presently, times are difficult for many agricultural producers. However, Chapter 12 bankruptcy has several very helpful provisions to ease the pain of restructuring the family farming business so that it can continue. The tools-of-the-trade exemption is one of those provisions that can be of assistance.
Thursday, November 1, 2018
Because such items as livestock, feed, seed or pesticides are goods, sales and other transactions involving them result in the creation of warranties. These warranties can be either express or implied. Express warranties are stated as part of the sales agreement and become part of the basis of the bargain, but implied warranties are read into the sales agreement by the law, absent specific language or circumstances excluding them.
Contract warranties create legal rights and liabilities between the parties to the transaction. That means knowing whether and how they can be disclaimed can be important.
Disclaiming implied warranties – that’s the topic of today’s post.
Methods for Disclaiming
The Uniform Commercial Code (UCC) specifically provides three ways in which all implied warranties can be excluded. First, unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like “as is,” “with all faults” or other language which in common understanding calls the buyer’s attention to the exclusion of warranties and makes plain that there is no implied warranty. For example, in Rayle Tech, Inc. v. DEKALB Swine Breeders, Inc. 133 F.3d 1405 (11th Cir. 1998), the court held that a swine breeder who purchased diseased pigs could not sue the seller for fraud where the seller clearly disclaimed any liability for disease in the sales contract, despite a salesman’s assurances to the contrary. However, in Snelten v. Schmidt Implement Co. 269 Ill. App.3d 988, 647 N.E.2d 1071 (1995), the court held that an implement dealer that sold a tractor to a farmer limited the scope of its “as is” disclaimer by making other representations to the buyer.
The second manner in which an implied warranty can be excluded is when the buyer, before entering into the contract, examines the goods or a sample or a model as fully as desired or refuses to examine the goods. In this instance, there is no implied warranty with regard to defects which an examination should have revealed to the buyer.
The third way an implied warranty can be excluded is by course of dealing, course of performance or usage of trade. UCC § 2-316(3)(C). The seller’s relationship with the buyer, industry practice or usage of trade can exclude an implied warranty. For example, if the parties have previously engaged in contracts for the sale of livestock or feed with all previous contracts containing a disclaimer provision, or the industry practice is to limit liability, implied warranties may be excluded.
Federal Statutory Law
At the federal level, the Magnuson-Moss Warranty Federal Trade Commission Improvement Act (15 U.S.C. §§ 2301-2312) precludes the disclaimer or modification of any implied warranty created by state law when a consumer product supplier makes any written warranty with respect to a product. The implied warranties can only be limited to the duration of the express warranties, unless the express warranties are designed as a “Full Warranty,” in which case the implied warranties cannot be limited even in their duration. Thus, the only way for a consumer product supplier to avoid extending implied warranties is to not provide any express warranties. Also laws in some states prohibit sellers in consumer transactions from excluding, modifying or limiting implied warranties of merchantability or fitness. For example, in Kansas, a supplier in a consumer transaction is prohibited from disclaiming or limiting UCC implied warranties of merchantability and fitness for a particular purpose. See, e.g., Kan. Stat. Ann. §§ 50-623 to 50-644. Any such limitation is usually considered void unless the buyer knew of the defect before purchasing and this knowledge became part of the basis of the sale. The only exceptions are for sales of livestock for agricultural purposes and sales of seed for planting.
In seed sale transactions, the Federal Seed Act (FSA) allows the seed sellers to use disclaimers, limited warranties, or non-warranty clauses in invoices, advertising or labeling. However, the FSA does not permit such limitation on warranties to be used as a defense in any criminal prosecution or other civil proceeding based on the FSA. 7 U.S.C. § 1574 (1995). As a result, seed purchasers may be faced with label disclaimers limiting liability to the price of the seed. Courts are split on the validity of such disclaimers with most courts invalidating them only if liability results from the seller’s own negligence or intentional violation of the law.
In order to disclaim or modify an implied warranty of merchantability, the seller’s “language must mention merchantability and in case of a writing must be conspicuous....” UCC § 2-316(2). For example, in Day v. Tri-State Delta Chemicals, Inc., 165 F. Supp. 2d 830 (E.D. Ark. 2001), the court determined that there had been no breach of an implied warranty in a transaction involving cotton seed purchased on credit where the credit agreement carried a limitation of warranty denying any representation as to the seed’s fitness.
Oral disclaimers of implied warranties of merchantability must use the word “merchantability,” and in written disclaimers, the disclaiming language must be conspicuous within the written document. See, e.g., R.J. Meyers Company v. Reinke Manufacturing Co., 885 N.W.2d 429 (Iowa Ct. App. 2016). A disclaimer of an implied warranty of fitness for a particular purpose must be in writing.
Transactions involving the sales of goods often occur without any issue. However, it is helpful to know what the rules concerning the disclaimer of implied warranties are in case an issue concerning the purchased goods arises and the goods don’t live up to the buyer’s expectations.
Tuesday, October 30, 2018
Many farming and ranching operations are structured in the partnership form, and many of them operate simply on an oral basis. The lack of a written partnership agreement can cause numerous problems. One of those problems can be uncertainty that results when a partner dies. What happens to the deceased partner’s partnership interest? Is it allocated among the surviving partner(s)? Does it pass to the deceased partner’s spouse or other heirs? Does something else happen to it?
The passage of a deceased partner’s partnership interest into the “wrong” hands can create various problems – not the least of which is possible discontinuation of the partnership business and farm business assets, including land, falling into hands of persons that have no interest in continuing the farming or ranching business. Even if a written partnership agreement exists, lack of clear language can also create uncertainty as to what happens when a partner dies.
Partnerships and the death of a partner – That’s the focus of today’s post.
What Is A Partnership?
First things first – when does a partnership exist? A partnership is an association of two or more persons to carry on as co-owners a business for profit. Uniform Partnership Act, § 6. As an estate planning device, the partnership is generally conceded to be less complex and less costly to organize and maintain than a corporation. A general partnership is comprised of two or more partners. There is no such thing as a one-person partnership, but there is no maximum number of partners that can be members of any particular general partnership.
If there is a written partnership agreement, that usually settles the question of whether the arrangement is a partnership. A partnership agreement (or articles of partnership) is a contract among the parties in which they agree to certain arrangements about income, rights to decision making, and accounting procedures. These are the practical kinds of problems that are addressed in a partnership agreement.
If there is no written partnership agreement, questions may arise as to whether a landlord/tenant lease arrangement constitutes a partnership. Because a partnership is an agreement between two or more individuals to carry on as co-owners a business for profit, a partnership generally exists when there is a sharing of net income and losses. There are numerous factors for determining partnership existence, but one of those involves the sharing of net income – an issue that can arise in oral lease arrangements.
Is a lease a partnership? A crop-share lease shares gross income, but not net income because the tenant still has some unique deductions that are handled differently than the landlord's. For example, the landlord typically bears all of the expense for building maintenance and repair, but the tenant bears all the expense for machinery and labor. Thus, there is not a sharing of net income and the typical crop-share lease is, therefore, not a partnership. Likewise, a livestock share lease is usually not a partnership because both the landlord and the tenant will have unique expenses. But, if a livestock share lease or a crop-share lease exists for some time and the landlord and tenant start pulling out an increased amount of expenses and deducting them before dividing the remaining income, then the arrangement will move ever closer to partnership status. When the arrangement arrives at the point where there is a sharing of net income, a partnership exists.
For written farm leases where partnership treatment is not desired, it is often suggested to have written into crop-share and livestock-share leases a provision specifying that the arrangement is not to be construed as a partnership. In addition, it’s advisable for the landlord and tenant to not hold themselves out publicly as being in a partnership.
Death of a Partner
As mentioned, if a partnership arrangement exists, the death of a partner can create issues. For example, in In re Estate of Humphreys, No. E2009-00114-COA-R3-CV, 2009 Tenn. App. LEXIS 716 (Tenn. Ct. App. Oct. 28, 2009), a farmer died intestate and an implied partnership was deemed to exist with the decedent’s surviving spouse which entitled the surviving spouse to one-half of the assets of the farm business with the balance distributed to the decedent’s estate. While the couple filed Schedule F only in the decedent’s name, the Schedule F included the incomes of both the decedent and the surviving spouse.
Similarly, in a case from Montana in 1985, In re Estate of Palmer, 218 Mont. 285, 708 P.2d 242 (1985), the court determined that a partnership existed even though title to the real estate and the farm bank account were in joint tenancy. As such, the surviving spouse of the deceased “partner” was entitled to one-half of the farm assets instead of the land and bank account passing to the surviving joint tenant.
A recent North Dakota case involving the death of a partner illustrates what can happen in the written partnership agreement doesn’t clearly address the matter of a partner’s death. In, Estate of Moore v. Moore, 2018 N.D. 221 (2018), two brothers were co-equal partners in a farming partnership. Under the written partnership agreement, upon the death of a partner, the partnership continued, but the estate of a deceased partner could not make business decisions without the surviving partner’s approval. Also, the written partnership agreement stated that, “Land owned as tenants in common by [the partners] is contributed to the partnership without charge.
The partnership was responsible for all of the costs and management associated with the land and treated the land as if it were owned by the partnership. This contribution could not be retracted except on dissolution of the partnership or agreement by both partners. The partnership agreement also specified that, “Any land owned [by] other persons operated by the partnership is leased by the partnership and not by individual partners.”
One of the partners died in 2012, and his will devised part of his land to his brother and the rest to his step children and nephew. The land that was devised to the step-children and nephew was burdened with a condition stating that the property should, "be sold in a commercially reasonable manner so as to derive the most value therefrom within six (6) months of my death." In 2012 this land was conveyed to the children and they also requested partition and sale of the land held as co-tenants. The defendant challenged the conveyance stating the estate should have sold the property rather than conveying it.
In 2014 the trial court agreed and vacated the conveyance and returned the property to the deceased partner’s estate. The surviving partner continued to farm, and the deceased partner’s estate sued for rent due on the partnership property. The trial court denied the estate rent, stating that partnership was not liable for rent six months after the decedent’s death. It also determined that the agreement continued the partnership for six months so that the surviving partners could decide what to do. The trial court also held that the partnership lacked standing during the litigation between 2012 and 2014 over the conveyance because the estate did not own the property. Finally, the trial court held that the estate did not show that they were due relief as they could not show that the defendant was unjustly enriched.
On appeal, the appellate court affirmed in part, reversed in part, and remanded the case. The appellate court, based on the partnership agreement, determined that the partnership was not dissolved upon death, but that the estate became a partner that was owed profits and losses. The appellate court determined that the district court erred when interpreting the statement in the partnership agreement that, "the partners intend… that there be an extended time to deal with a partner leaving or the death of a partner before the necessary wind up of the partnership or its continuation by the remaining partners." The appellate court held that this did not invoke a dissolution and winding up period after one of their deaths. Because the appellate court held that the partnership was not dissolved, and the land was held as co-tenants, there was no rent due. The partnership was still valid, and the land was being used within the guidelines of the agreement. As a result, the use of the land was correct, the surviving partner was not unjustly enriched, bur was merely continuing the business as a partner.
The ultimate holding of the appellate court affirmed that the estate was not due any rent between the decedent’s death and sale of the property. However, the estate may be still owed profits from the partnership. Since the estate became a partner, with limited abilities, the court remanded the case for an accounting of profits or losses after the decedent’s death.
A partnership is often a preferred form of business organization for a farm or ranch business. It’s best to formalize the arrangement with a carefully crafted written agreement. Death of a partner is one of those issues that a written agreement should address. If it doesn’t, or the arrangement is an oral one, unexpected consequences can result.
Friday, October 26, 2018
The TCJA eliminated tax-deferred like-kind exchanges of personal property for exchanges completed after 2017. However, exchanges of real estate can still qualify for tax-deferred treatment if the exchange involves real estate that is “like-kind.” But, what does that mean?
Real estate tax-deferred trades and what counts as “like-kind” – that’s the focus of today’s post.
Definition of “Real Estate”
Broad definition. Under the former rules governing trades of personal property, such as farm machinery, the Treasury Regulations determined if property was like-kind by reference to being within the same product class. See Treas. Reg. §1.1031-2(b)(2). Also, property was of a like-kind to property that was of the same nature or character. See Temp. Treas. Reg. §1.1031(a)-2T(d). However, like-kind property personal property did not necessarily have to be of the same grade or quality. In addition, for intangible assets, the determination of like-kind had to be made on an asset-by-asset basis. Thus, a like-kind trade could involve a bull for a bull, a combine for a combine, but not a combine for a sports car or a farm or ranch for publicly traded stock.
With respect to real estate, a much broader definition of like-kind applies. Virtually any real estate used for business or investment can be exchanged for any other real estate if the taxpayer continues to use the replacement property for business or investment. The regulations define “like-kind” in terms of reference to the nature or character of the replacement property rather than its grade or quality. Treas. Reg. §1.1031(a)-1(b); see also C.C.M. 201238027
In addition, it doesn’t matter whether the real estate involved in a tax-deferred exchange is improved or unimproved. Treas. Reg. §1.1031(a)-1(b), (c). Thus, agricultural real estate may be traded for residential real estate. However, if bare farmland is traded for farmland with depreciable structures on it, tax issues can arise. Many farm depreciable buildings and structures are “I.R.C. §1245 property.” For example, commodity storage facilities and single-purpose agricultural structures are I.R.C. §1245 property, as are irrigation systems, drainage tile, and other improvements to farm real estate. If property with an I.R.C. §1245 depreciation recapture attribute is disposed of in an I.R.C. §1031 exchange, the I.R.C. §1245 depreciation recapture must be recognized to the extent that the replacement property has insufficient I.R.C. §1245 property. IRS Form 8824 provides a location for reporting the I.R.C. §1245 depreciation recapture if non-I.R.C. §1245 property is received in the exchange.
Unique situations. While the definition of real estate is rather broad, some distinctions are present. For example, a leasehold interest can be exchanged for fee interests if the leasehold interest has at least 30 years to run at the time the exchange is entered into. Treas. Reg. §1.1031(a)-1(c). Case law also indicates that, at the time the transaction is entered into, the lease must have at least 30 years remaining. See, e.g., VIP Industries Inc. & Subsidiaries v. Comm’r, T.C. Memo. 2013-357.
That 30-year rule is important. The IRS has, apparently, taken the position that an exchange of a remainder interest in a tract of real estate for a life estate (where the life expectancy of the life tenant exceeds 30 years) for another tract of real estate can qualify for like-kind exchange treatment. Rev. Rul. 72-601, 1977-2 C.B. 467. Likewise, a remainder interest in real estate can qualify for like-kind exchange treatment when it is exchanged for a remainder interest (or, probably, a reversionary interest) in a different tract of farmland. Rev. Rul. 78-4, 1978-1 C.B. 256. Also, real estate owned in fee simple can qualify for like-kind exchange treatment when traded for real estate subject to 99-year leases. See, e.g. Koch v. Comr., 71 T.C. 54 (1978).
Also, a sale followed by a leaseback involving terms of 30 years or more has been deemed to be like-kind. Rev. Rul. 60-43, 1960-1 C.B. 687; Jordan Marsh Company v. Comr., 269 F.2d 453 (2d Cir. 1959).
As for land that is being sold under an installment land contract, the buyer’s rights under the contract have been held to be the same as a fee simple interest in the real estate. See, e.g., Starker v. Comr., 602 F.2d 1341 (9th Cir. 1979).
In Peabody Natural Resources Co. v. Comr., 126 T.C. 261 (2006), the Tax Court determined that under New Mexico law, coal supply contract constituted real property interests and were like-kind to gold mine. The case involved the exchange of an operating gold mine, including real estate, for operating coal mines which were subject to coal supply contracts obligating the owner to provide electric utilities with coal. The IRS denied like-kind exchange treatment on the basis that the coal supply contracts weren’t real property. However, the Tax Court determined that under New Mexico law (the state where the coal mines were located) the coal contracts were servitudes (an interest on the underlying land) under New Mexico law. As for the nature and character of the contracts, the Tax Court determined that they couldn’t be separated from the ownership of the coal reserves. They were ancillary to the ownership of the coal reserves. As a result, the contracts were like-kind to the gold mining property.
Perpetual water rights are like-kind to land. Rev. Rul. 55-749, 1955-2 C.B. 295. However, water rights that are limited in duration are not considered like-kind to a fee interest in land. Wiechens v. United States, 228 F. Supp. 2d 1080 (D. Ariz. 2002). But, there can be an exception to that outcome. If the water rights are limited only as to annual use the IRS has ruled that they are of sufficient like-kind to a fee interest in land to qualify the transaction for like-kind exchange treatment. Priv. Ltr. Rul. 200404044 (Oct. 23, 2003).
Impact of State Law
It could be concluded from a read of the above cases and rulings that state law plays a predominant role in determining whether a property interest is an interest in real property that can potentially be eligible for like-kind exchange treatment. That was certainly the case in the early cases dealing with the issue. See, e.g., Morgan v. Comr., 309 U.S. 78 (1940); Aguilino v. United States, 363 U.S. 509 (1960); Comr. v. Crichton, 122 F.2d 181 (5th Cir. 1941); Priv. Ltr. Rul. 200424001 (Dec. 8, 2003). But, other cases indicate that the like-kind determination is a matter of federal law rather than state law. See, e.g., Fleming v. Comr., 24 T.C. 818 (1955), rev’d., 241 F.2d 78 (5th Cir. 1957).
In 2012, the IRS clarified its position on the impact of state law in determining whether a property interest is in interest in real property. In C.C.A. 201238027 (Sept. 21, 2012), the IRS determined that federal income tax law, not state law, controls whether exchanged properties are of like kind for I.R.C. §1031 purposes. While the IRS stated that state law property classifications are relevant for determining if property is real or personal, they aren't determinative of whether properties are of the same nature and character. Instead, that determination is to be made by considering all of the facts and circumstances of the particular transaction and the property interests involved. Id.
The TCJA eliminated the ability to treat personal property trades under the I.R.C. §1031 rules. However, real estate can still be traded in a tax deferred exchange transaction. What constitutes “real estate” is an important first determination. The nature and character of the properties involved in the transaction is the next determination. If those hurdles are successfully cleared, the I.R.C. §1031 rules can provide a preferential tax result.
Wednesday, October 24, 2018
An issue that can be confusing and difficult to understand is the proper classification of items of depreciable real estate for a farm taxpayer. More specifically, how are farm “buildings” and other structures treated for depreciation purposes? The Tax Code (Code) treats “buildings” and “structures” in a special way. But, that treatment is not always intuitive.
So just what is a “farm building”? What is depreciable farm real property? What is the appropriate tax treatment of these items for depreciation purposes? That’s the topic of today’s post.
“Buildings and Structures”
The IRS classifies depreciable farm real property in at least four ways. Land improvements have a cost recovery period of 15 years and are in depreciation class 00.3 (Modified Accelerated Cost Recovery System depreciation class). Single purpose agricultural or horticultural structures are in Class 01.4 and have a cost recovery period of 10 years. The cost recovery period for farm buildings is 20 years, and they are in Class 01.3. What is known as I.R.C. §1245 real property has no class life and a cost recovery period of seven years. The specifications are set forth in Rev. Proc. 87-56, 1987-2 C.B. 674.
In general, depreciable real estate must use straight-line depreciation. I.R.C. §168(b)(3). But, that’s not the case for depreciable real estate that has a recovery period of less than 27.5 years. I.R.C. §168(e)(2)(B). As such, the applicable depreciation method for depreciable farm real estate is the 150 percent declining balance method.
Land improvements. A land improvement is a tangible depreciable item that is added to the underlying land. It is either I.R.C. §1245 or I.R.C. §1250 property. Such items as sidewalks, roads, canals, waterways, wharves, docks, bridges, fences, landscaping, shrubbery and transmission towers all meet the definition of a land improvement. Other land improvements (and similar structures) include such things as silage bunkers, concrete ditches, stock watering pond outlets and wells used for irrigation and livestock watering. See Rev. Proc. 87-56, 1987-2 C.B. 674.
Sometimes farmers and ranchers incur costs for improvements associated with windbreaks, excavation, dredging, and other earth moving activities. The common IRS position on the cost of these types of improvements is that they are not depreciable and must be capitalized into the cost basis of the underlying land. See, e.g., Everson v. United States, 108 F.3d 234 (9th Cir. 1997). However, they might be depreciable if the taxpayer can establish that the improvement will deteriorate over time and ultimately become worthless unless it is maintained (and the exhaustion of the asset can be measured). See, e.g., Ekberg v. United States, No. 711 W.D., 1959 U.S. Dist. LEXIS 4467 (D. S.D. 1959); Rev. Rul. 75-137, 1975-1 C.B. 74; Rudolph Investment Corp. v. Comr., T.C. Memo. 1972-129. Associated maintenance costs would be currently deductible as a repair expense.
Single purpose structures. The definition of a single purpose agricultural or horticultural structure is contained in I.R.C. §48(p), even though that Code section has since been repealed. Under that definition, a single purpose agricultural or horticultural structure is one that is used for the housing, raising and feeding of a particular type of livestock and the associated equipment that is required to properly house, raise and feed the livestock. I.R.C. §48(p)(2)[repealed]. Examples of these structures on a farm include hog houses, poultry barns, livestock sheds, milking parlors and similar structures.
Likewise, a single purpose agricultural or horticultural structure includes a greenhouse that is specifically designed, constructed and used for the commercial production of plants. I.R.C. §48(p)(3)(B)[repealed].
I.R.C. §1245 assets and I.R.C. §38. Assets which have the appearance of a building but qualify as I.R.C. §1245 assets (and not separately classified as single purpose ag or horticultural structures) are not “buildings” Treas. Reg. 1.48-1(e)(1)(i)]. They are, in essence, items of machinery or equipment which are an “integral part of manufacturing [or] production” I.R.C. §1245(a)(3)(B)(i)]. Structures such as storage facilities for potatoes, onions and other cold storage facilities for fruits and vegetables are included in this category. But, if the structure is used for other purposes after the commodities have been removed, the structures are buildings, rather than I.R.C. §1245(a)(3).
Now repealed I.R.C. §48(a)(1)(B)(i) defined property which qualified for the I.R.C. §38 investment tax credit (ITC). The Tax Reform Act of 1986 moved that language into I.R.C. §1245 for depreciation recapture purposes. Thus, property that qualified as pre-1986 investment tax credit property will qualify as property defined under I.R.C. §1245(a)(3).
For property that is easily adaptable to other uses, it is properly classified as a building. For example, a building with a kit installed for commodity storage did not qualify for the ITC. Tamura v. United States, 734 F.2d 470 (9th Cir. 1984); Bundy v. United States, No. CV85-L-575, 1986 U.S. Dist. LEXIS 17497 (D. Neb. 1986). However, if the property is of special design and unsuitable for other uses, it is not a building. See, e.g., Palmer Olson v. Comm., TC Memo 1970-296. Obviously, the proper determination is based on the facts of the particular situation. The key question is whether a particular structure is closely related to the use of the property that it houses based on its design and whether it can be economically used for other purposes. See, e.g., Priv. Ltr. Rul. 200013038 (Dec. 27, 1999).
Farm buildings. Farm buildings are defined by default – they are depreciable structures that don’t fit in any other class. Examples include shops, machine sheds and other general purpose buildings on a farm that are not integral to the manufacturing, production or growing process. “Hoop” structures generally fit in this category as a general purpose farm building. At least that’s the likely IRS position. Granted, a fact-dependent argument can be made that a hoop structure is used as an integral part of production or is akin to a bulk storage facility used in connection with production. If that argument prevails, a hoop structure is I.R.C. §1245 property with no class life and a seven-year recovery period. In that case, a hoop structure would be eligible for I.R.C. §179 depreciation, and would also potentially be eligible for first-year “bonus” depreciation. The key to the determination a hoop structure’s status is determining whether it is easily adaptable to other uses. If it is, it is properly classified as a “building.”
What About I.R.C. §179 Depreciation?
The Tax Cuts and Jobs Act (TCJA) increased the maximum level of expense method (I.R.C. §179) depreciation to $1,000,000 with the phase-out set at $2,500,000 of qualified assets purchased and placed in service during the year. Do the various structures mentioned above qualify for I.R.C. §179? If the structure is a general purpose ag building, it would not qualify for I.R.C. §179 depreciation. However, property that is “other property,” that is not a building or its structural components, used as an integral part of manufacturing or production qualifies for I.R.C. §179. I.R.C. §179(d)(1)(B). That definition includes single purpose ag and horticultural structures. I.R.C. §1245(a)(3)(D)]. Land improvements, such as irrigation and livestock watering wells and silage bunkers, may qualify for I.R.C. §179 if they are used in the manufacturing, production or growing process. I.R.C. §1245(a)(3)(B)(i). Similarly, grain storage in connection with a manufacturing and production activity qualifies for I.R.C. §179 by virtue of I.R.C. §1245(a)(3)(B)(iii).
The TCJA made changes to the Code’s cost recovery provisions. For tax years beginning after 2017, a five-year recovery period applies for machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business, the original use of which commences with the taxpayer and is placed in service after December 31, 2017.
The TCJA also repeals the required use of the 150-percent declining balance method for property used in a farming business (i.e., for 3, 5, 7, and 10-year property). But, the 150 percent declining balance method will continue to apply to any 15-year or 20-year property used in the farming business to which the straight-line method does not apply, or to property for which the taxpayer elects the use of the 150-percent declining balance method.
However, those TCJA modifications don’t change the rules for determining what is a “farm building” or depreciable farm real property. Those tricky rules and factual situations remain.
Monday, October 22, 2018
The purpose of the Clean Water Act (CWA) is to eliminate the discharge of pollutants into the nation's waters without a permit. The CWA recognizes two sources of pollution. Point source and nonpoint source pollution. Under the CWA, point source pollution is the concern of the federal government and it is the type of pollution that comes from a clearly discernable discharge point, such as a pipe, a ditch, or a concentrated animal feeding operation. Nonpoint source pollution, while not specifically defined under the CWA, is pollution that comes from a diffused point of discharge, such as fertilizer runoff from an open field. Control of nonpoint source pollution is to be handled by the states through enforcement of state water quality standards and area-wide waste management plans.
What if pollution enters CWA-regulated waters (“Waters of the United States”) through groundwater? Is groundwater a point source of pollution? If so, that has serious implications for agriculture. A recent federal appeals court opinion brings good news for agriculture. It also creates a split amongst the courts that the U.S. Supreme Court may be asked to resolve.
Groundwater and point-source pollution – that’s the topic of today’s post.
The CWA and “Point Source” Pollution
No one may discharge a “pollutant” from a point source into the “navigable waters of the United States” without a permit from the EPA. An NPDES permit is not required unless there is an “addition” of a pollutant to regulable waters. See e.g., Friends of the Everglades, et al. v. South Florida Water Management District, et al., 570 F.3d 1210 (11th Cir. 2009) reh’g., den., 605 F.3d 962 (11th Cir. 2010), cert. den., 131 S. Ct. 643 (2010).
The definition of “pollutant” has been construed broadly to include the tillage of soil which causes the soil to be “redeposited” into delineated wetlands constitutes the discharge of a “pollutant” into the navigable waters of the United States requiring an NPDES permit. See, Duarte Nursery, Inc. v. United States Army Corps of Engineers , No. 2:13-cv-02095-KJM-AC, 2016 U.S. Dist. LEXIS 76037 (E.D. Cal. Jun. 10, 2016). The court also determined that farming equipment, a tractor and ripper attachment constituted a point source pollutant under the CWA. The discharge was not exempt under the “established farming operation” exemption of 33 U.S.C. §1344(f)(1) because farming activities on the tract had not been established and on-going but had been grazed since 1988. As a result, the planting of wheat could not be considered a continuation of established and on-going farming activities. Id.
Under 1977 amendments to the CWA, irrigation return flows are not considered point sources. See, e.g., Pacific Coast Federation of Fishermen’s Associations, et al. v. Glaser, et al., No. CIV S-2:11-2980-KJM-CKD, 2013 U.S. Dist. LEXIS 132240 (E.D. Cal. Sept. 16, 2013). In Pacific Coast, the plaintiff directly challenged the exemption of tile drainage systems from CWA regulation via “return flows from irrigated water” on the basis that groundwater discharged from drainage tile systems is separate from any irrigation occurring on farms and is, therefore, not exempt. In dismissing the case, the court also noted that “return flows” narrows the type of water permissibly discharged from irrigated agriculture and covers discharges from irrigated agriculture that don’t contain additional discharges unrelated to crop production.
What About Groundwater?
The NPDES system only applies to discharges of pollutants into surface water. Discharges of pollutants into groundwater are not subject to the NPDES permit requirement even if the groundwater is hydrologically connected to surface water. Indeed, the legislative history of the CWA demonstrates that the Congress, did not intend that the CWA regulate hydrologically-connected groundwater. Groundwater regulation was to be left to the states as nonpoint source pollution. See, e.g., Umatilla Water Quality Protective Association v. Smith Frozen Foods, 962 F. Supp. 1312 (D. Or. 1997).
While it seems clear that the CWA was never intended to apply to pollution discharges into groundwater that eventually finds its way into a WOTUS, in recent years a split has developed between a few of the federal circuit courts of appeal. For example, in Upstate Forever, et al. v. Kinder Morgan Energy Partners, LP, et al., 887 F.3d 637 (4th Cir. 2018), the plaintiffs, a consortium of environmental and conservation groups, brought a citizen suit under the Clean Water Act (CWA) claiming that the defendant violated the CWA by discharging “pollutants” into the navigable waters of the United States without a required discharge permit via an underground ruptured gasoline pipeline owned by the defendant’s subsidiary. The plaintiff claimed that a discharge permit was needed because the CWA defines “point source pollutant” (which requires a discharge permit) as “any discernible, confined and discrete conveyance, included but not limited to any…well…from which pollutants are or may be discharged.”
The trial court dismissed the plaintiffs’ claim, but the appellate court held that a pollutant can first move through groundwater before reaching navigable waters and still constitute a “discharge of a pollutant” under the CWA that requires a federal discharge permit. The discharge need not be channeled by a point source until reaching navigable waters that are subject to the CWA. The appellate court did, however, point out that a discharge into groundwater does not always mean that a CWA discharge permit is required. A permit in such situations is only required if there is a direct hydrological connection between groundwater and navigable waters. In the present case, however, the appellate court noted that the pipeline rupture occurred within 1,000 feet of the navigable waters. The court noted that the defendant had not established any independent or contributing cause of pollution.
Similarly, in Hawai’i Wildlife Fund v. Cty. of Maui, 881 F.3d 754 (9th Cir. 2018), the defendant owned and operated four wells at the Lahaina Wastewater Reclamation Facility (LWRF), which is the principal municipal wastewater treatment plant for a city. Although constructed initially to serve as a backup disposal method for water reclamation, the wells became the defendant’s primary means of effluent disposal into groundwater and, ultimately, the Pacific Ocean. The LWRF received approximately 4 million gallons of sewage per day from a collection system serving approximately 40,000 people. That sewage was treated at LWRF and then either sold to customers for irrigation purposes or injected into the wells for disposal. The defendant injected approximately 3 to 5 million gallons of treated wastewater per day into the groundwater via its wells. The defendant conceded, and its expert, confirmed that wastewater injected into wells 1 and 2 enters the Pacific Ocean. In addition, in June 2013 the EPA, the Hawaii Department of Health, the U.S. Army Engineer Research and Development Center, and researchers from the University of Hawaii conducted a study on wells 2, 3 and 4. The study involved placing tracer dye into Wells 2, 3, and 4, and monitoring the submarine seeps off Kahekili Beach to see if and when the dye would appear in the Pacific Ocean. This study, known as the Tracer Dye Study, found that 64% of the treated wastewater from wells 3 and 4 discharged into the ocean.
The plaintiff sued, claiming that the defendant was in violation CWA by discharging pollutants into a WOTUS without a permit. The trial court agreed, holding that a permit was required for effluent discharges into navigable waters via groundwater. On appeal, the appellate court held that the wells were point sources that could be regulated through CWA permits despite the defendant’s claim that a permit was not required because the wells discharged only indirectly into the Pacific Ocean via groundwater. Specifically, the appellate court held that “a point source discharge to groundwater of “more than [a] de minimis” amount of pollutants that is “fairly traceable from the point source . . . such that the discharge is the functional equivalent of a discharge into a navigable water” is regulated under the CWA.”
A recent decision by the U.S. Circuit Court of Appeals for the Sixth Circuit, however, reached a different decision. In Tennessee Clean Water Network v. Tennessee Valley Authority, No. 17-6155, 2018 U.S. App. LEXIS 27237 (6th Cir. Sept. 24, 2018). The defendant, a utility that burns coal to produce energy, produces coal ash as a byproduct. The coal ash is discharged into man-made ponds. The plaintiffs, environmental activist groups, claimed that the chemicals from the coal ash in the ponds leaked into surrounding groundwater where it was then carried to a nearby lake that was subject to regulation under the Clean Water Act (CWA). The plaintiffs claimed that the contamination of the lake without a discharge permit violated the CWA and the Resource Conservation and Recovery Act (RCRA). The trial court had dismissed the RCRA claim but the appellate court reversed that determination and remanded the case on that issue.
On the CWA claim, the trial court ruled as a matter of law that the CWA applies to discharges of pollutants from a point source through hydrologically connected groundwater to navigable waters where the connection is "direct, immediate, and can generally be traced." The trial court held that the defendant’s facility was a point source because it "channel[s] the flow of pollutants . . . by forming a discrete, unlined concentration of coal ash," and that the Complex is also a point source because it is "a series of discernible, confined, and discrete ponds that receive wastewater, treat that wastewater, and ultimately convey it to the Cumberland River." The trial court also determined that the defendant’s facility and the ponds were hydrologically connected to the Cumberland River by groundwater. As for the defendant’s facility, the court held that "[f]aced with an impoundment that has leaked in the past and no evidence of any reason that it would have stopped leaking, the Court has no choice but to conclude that the [defendant’s facility] has continued to and will continue to leak coal ash waste into the Cumberland River, through rainwater vertically penetrating the Site, groundwater laterally penetrating the Site, or both." The trial court determined that the physical properties of the terrain made the area “prone to the continued development of ever newer sinkholes or other karst features." Thus, based on the contaminants flowing from the ponds, the court found defendant to be in violation of the CWA. The trial court also determined that the leakage was in violation of the defendant “removed-substances” and “sanitary-sewer” overflow provisions. The trial court ordered the defendant to "fully excavate" the coal ash in the ponds (13.8 million cubic yards in total) and relocate it to a lined facility.
On further review, the appellate court reversed. The appellate court held that the CWA does not apply to point source pollution that reaches surface water by means of groundwater movement. The appellate court rejected the plaintiffs’ assertion that mere groundwater is equivalent to a discernable point source through which pollutants travel to a CWA-regulated body of water. The appellate court noted that, to constitute a “conveyance” of groundwater governed by the CWA, the conveyance must be discernible, confined and discrete. While groundwater may constitute a conveyance, the appellate court reasoned that it is neither discernible, confined nor discrete. Rather, the court noted that groundwater is a “diffuse medium” that “seeps in all directions, guided only by the general pull of gravity. This it [groundwater] is neither confined nor discrete.” In addition, the appellate court noted that the CWA only regulates pollutants “…that are added to navigable waters from any point source.” In so holding, the court rejected the holdings in of the prior decisions of the Fourth and Ninth Circuits.
The Sixth Circuit’s decision is a breath of fresh air for agriculture. It is the state’s responsibility to regulate nonpoint source pollution. A hydrological connection was never intended to suffice for federal jurisdiction under the CWA, and the Sixth Circuit said that the other courts finding as such was “misguided.” The Sixth Circuit stated, “Reading the CWA to extend liability to groundwater pollution is not the best one.”
Groundwater is not a point source. The Sixth Circuit’s opinion has big implications for agricultural farming activities and will help keep the federal government out of the farm field in Kentucky, Michigan, Ohio and Tennessee. It’s also likely that the U.S. Supreme Court will be asked to clear up the split between the circuit courts. Stay tuned.
Thursday, October 18, 2018
For the Spring 2019 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.
Details of next spring’s online Ag Law course – that’s the topic of today’s post.
The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?
Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.
Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.
Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate. A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?
Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.
Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.
Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.
Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.
Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.
Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.
Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.
Further Information and How to Register
Information about the course is available here:
You can also find information about the text for the course at the following link (including the Table of Contents and the Index):
If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution. Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.
If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.
I hope to see you in January!
Checkout the postcard (401 KB PDF) containing more information about the course and instructor.
October 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Tuesday, October 16, 2018
In recent years, all states except California and Maryland have enacted Equine Activity Liability Acts designed to encourage the continued existence of equine-related activities, facilities and programs, and provide the equine industry limited protection against lawsuits. The laws vary from state-to-state, but generally require special language in written contracts and liability releases or waivers, require the posting of warning signs and attempt to educate the public about inherent risks in horse-related activities and immunities designed to limit liability. The basic idea of these laws is to provide a legal framework to incentivize horse-related activities by creating liability protection for horse owners and event operators.
Equine activity laws – that’s the topic of today’s post.
State Law Variations
The typical statute covers an “equine activity sponsor,” “equine professional,” or other person (such as an employer in an employment setting involving livestock) and specifies that such "covered" person can only be sued in tort for damages related to the knowing provision of faulty tack, failure to determine the plaintiff’s ability to safely manage a horse, or failure to post warning signs concerning dangerous latent conditions. See, e.g., Baker v. Shields, 767 N.W.2d 404 (Iowa 2009); Pinto v. Revere Saugus Riding Academy, No. 08-P-318, 2009 Mass. App. LEXIS 746 (Mass. Ct. App. Jun. 8, 2009). For example, in Germer v. Churchill Downs Management, No. 3D14-2695, 2016 Fla. App. LEXIS 13398 (Fla. Ct. Ap. Sept. 7, 2016), state law “immunized” (among other things) an equine activity sponsor from liability to a “participant” from the inherent risks of equine activities. The plaintiff, a former jockey visited a race course that the defendant managed. It was a spur-of-the-moment decision, but he was required to get a guest pass to enter the stables. He was injured by a horse in the stables and the court upheld the immunity provisions of the statute on the basis that the requirement to get a guest pass before entering the stables was sufficient protocol to amount to “organization” which made the plaintiff’s visit to the stables “an organized activity” under the statute.
While many state equine activity laws require the postage of warning signs and liability waivers, not every state does. For example, the statutes in CT, HI, ID, MT, NH, ND, UT, WA and WY require neither signage nor particular contract language.
Recovery for damages resulting from inherent risks associated with horses is barred, and some state statutes require the plaintiff to establish that the defendant’s conduct constituted “gross negligence,” “willful and wanton misconduct,” or “intentional wrongdoing.” For example, in Snider v. Fort Madison Rodeo Corp., No. 1-669/00-2065, 2002 Iowa App. LEXIS 327 (Iowa Ct. App. Feb. 20, 2002), the plaintiff sued a parade sponsor and a pony owner for injuries sustained in crossing the street during a parade. The court determined that the omission of a lead rope was not reckless conduct and that the plaintiff assumed the risk of crossing the street during the parade. Similarly, in Markowitz v. Bainbridge Equestrian Center, Inc., No. 2006-P-0016, 2007 Ohio App. LEXIS 1411 (Ohio Ct. App. Mar. 30, 2007), the court held that there was no evidence present that the plaintiff’s injuries sustained in the fall from a horse was a result of the defendant’s willful or wanton conduct or reckless indifference. In addition, the signed liability release form complied with statutory requirements. However, in Teles v. Big Rock Stables, L.P., 419 F. Supp. 2d 1003 (E.D. Tenn. 2006), the provision of a saddle with stirrups that could not be shortened enough to reach plaintiff’s feet which then caused the plaintiff to fall from a horse raised jury question as to whether faulty tack provided, whether the fall was the result of the inherent risk of horseback riding, and whether the defendant’s conduct was willful or grossly negligent and, thus, not covered by the signed liability release form.
What constitutes an “inherent risk” from horse riding is a fact issue in many states due to the lack of any precise definition of “inherent risk” in the particular state statute. For example, under the Texas Equine Activity Liability Act, the phrase “inherent risk of equine activity” refers to risks associated with the activity rather than simply those risks associated with innate animal behavior. See, e.g., Loftin v. Lee, No. 09-0313, 2011 Tex. LEXIS 326 (Tex. Sup. Ct. Apr. 29, 2011). The Ohio equine activities immunity statute has been held to bar recovery for an injury incurred while assisting an employer unload a horse from a trailer during a day off, because the person deliberately exposed themselves to an inherent risk associated with horses and viewed the activity as a spectator. Smith v. Landfair, No. 2011-1708, 2012 Ohio LEXIS 3095 (Ohio Sup. Ct. Dec. 6, 2012). Also, in Einhorn v. Johnson, et al., No. 50A03-1303-CT-93, 2013 Ind. App. LEXIS 495 (Ind. Ct. App. Oct. 10, 2013), the Indiana Equine Activity Act barred a negligence action after a volunteer at a county fair was injured by a horse. The plaintiff’s injuries were determined to result from the inherent risk of equine activities. Likewise, in Holcomb v. Long, No. A14A0815, 2014 Ga. App. LEXIS 726 (Ga. Ct. App. Nov. 10, 2014), the Georgia Equine Activities Act barred recovery for injuries sustained as a result of slipping saddle during horseback ride; slipping saddle inherent risk of horseback riding. See also, Fishman v. GRBR, Inc., No. DA 17-0214, 2017 Mont. LEXIS 602 (Mont. Sup. Ct. Oct. 5, 2017).
In Franciosa v. Hidden Pond Farm, Inc., No. 2017-0153 2018 N.H. LEXIS 174 (N. H. Sup. Ct. Sept. 21, 2018), the plaintiff was severely injured in a horseback riding accident. At the time of the accident, she was thirteen years old, had been riding horses for eight years, and had been taking weekly riding lessons from the defendant, an expert equestrian, for almost two years. Approximately once each seek, the plaintiff went for a “free ride”—a ride that did not involve a lesson. On those occasions the defendant was not always present, and no one was assigned to supervise the plaintiff. The day before the accident the plaintiff texted the defendant to arrange a lesson for the following day. The defendant texted the plaintiff that, although she would not be present at the farm on the following day, the plaintiff had permission to take a free ride on a horse that the plaintiff had ridden without incident on at least two occasions.
The next day after riding the horse for about 30 minutes the plaintiff fell to the ground as she tried to dismount and was seriously injured when the horse subsequently stepped on her. The plaintiff sued, and the defendant moved for summary judgment on the basis that the equine immunity provisions set forth N.H. Rev. Stat. §508:19 barred the plaintiff’s negligence claim. The plaintiff then filed a cross-motion for partial summary judgment, arguing that the plaintiff’s injuries were not caused by an “inherent risk” of horseback riding and, therefore, the defendant was not immune from liability. Alternatively, the plaintiff argued that even if the statute applied, a jury trial was necessary to resolve issues of material fact regarding the statutory exceptions in N.H. Rev. Stat. §508:19. The trial court entered summary judgment for the defendant, denied the plaintiff’s cross motion, and also denied the plaintiff’s motion for reconsideration.
On further review, the appellate court held that the statute clearly operated “to shield persons involved in an equine activity from liability for negligence claims related to a participant’s injuries resulting from the inherent risks of equine circumstances.” The appellate court also determined that it didn’t have to decide whether the defendant’s physical absence and inability to supervise the plaintiff at the time of the accident placed the accident outside of the risks inherent in equine activities, because under RSA 508:19, I(f)(5) a failure to take “corrective measures” was relevant only when the participant was negligent and that negligence can be reasonably foreseen, which was not present in the case. The court also determined that there was no evidence to support the plaintiff’s argument that the defendant’s failure to supervise the plaintiff amounted to willful or wanton disregard for the plaintiff’s safety. Consequently, the appellate court held that the trial court did not err in holding that the defendant was entitled to immunity under N.H. Rev. Stat. §508:19. As such, the decisions of the trial court were affirmed.
State Equine Activity Liability laws are designed to provide liability protection for injuries arising from horse-related activities. If you have horses or are involved in horse-related activities, it might be a good idea to determine what rules your particular state has.