Claiming “Bonus” Depreciation on Plants

An issue that we have been teaching at farm tax seminars this spring and summer (and, for me, at the farm income tax course at Washburn Law School this past May) involves new I.R.C. §168(k)(5) which was added to the Internal Revenue Code by “The Protecting Americans From Tax Hikes Act of 2015” (PATH Act) in late 2015.  That provision provides for an election that allows first-year “bonus” depreciation for certain plants equal to 50 percent of their cost (for 2016) that are planted or grafted after 2015.  The 50 percent continues through 2017, but drops to 40 percent for 2018 and 30 percent for 2019 and is presently set at zero after 2019. 

What type of plant is eligible?  Under the provision a “specified plant” is any tree or vine which bears fruit or nuts, and any other plant which will have more than a single yield of fruits or nuts and which generally has a pre-productive period of more than two years from the time of planting or grafting to the time at which the plant begins bearing fruits or nuts.  That definition leaves some uncertainty.  Does it include the plant plus all I.R.C. §263A pre-productive costs incurred for the year of planting?  If it does, then the amount that is available for bonus depreciation in the year of planting will include those costs.  On the other hand, if that definition only includes the cost of the plant, then pre-productive costs that are associated with developing the plant might not be included.  Perhaps the IRS will clarify the precise costs beyond the purchase cost of the plant that would be eligible for bonus depreciation in the year placed in service before 2020.

Let’s look at an example (thanks to Paul Neiffer in the Kennewick and Yakima offices of CliftonLarsonAllen, LLP and author of the farmcpatoday.com blog) to illustrate why additional clarity from the IRS is needed:

Gary plants a vineyard in April of 2016.  The cost of the plants is $100,000.  He also incurs pre-productive costs during the year of another $175,000.  The plants have their first marketable crop in 2019 after incurring additional pre-productive costs of $400,000 in 2017-2019.

Alternative # 1 – Pre-productive costs are included as part of “specified plant”

Gary makes the election to take 50% bonus depreciation on $275,000 of plants purchased in 2016 (including capitalized pre-productive costs) on the 2016 tax return.  This deduction is not added to his capitalized pre-productive costs.  He reduces the capitalized costs by this amount. In 2019, he places in service total capitalized costs of $537,500 ($100,000 + $175,000 -$137,500 + $400,000). During that year, bonus depreciation is not allowed, because he may claim bonus depreciation only once on the specified plant. The trellis and irrigation system are separate assets; bonus depreciation is available for the year the assets are placed in service, if before 2020.

If Gary did not make the election, he would have no deduction in 2016 (giving up a $137,500 deduction) and in 2019, he would place in service $675,000 ($100,000 + $175,000 + $400,000) that would be eligible for 30% bonus depreciation of $202,500. 

By making the election, Gary claims $137,500 of bonus depreciation in 2016 and normal depreciation on the balance, beginning in 2019. If he had not made the election, he would have a deduction of $202,500 for bonus depreciation in 2019 and normal depreciation on the balance, beginning in 2019.

However, if the first marketable harvest was not until 2020, then not making the election would prevent Gary from deducting any bonus depreciation (however I.R.C. §179 would still be available).

Alternative # 2 – Pre-productive costs are not included as part of “specified plant”

Gary makes the election to take 50% bonus depreciation on $100,000 of plants purchased in 2016 (does not include capitalized pre-productive costs) on the 2016 tax return.  This deduction is not added to his capitalized pre-productive costs.  He reduces the capitalized costs by this amount. In 2019, he places in service total capitalized costs of $625,000 ($100,000 - $50,000 + $175,000 + $400,000). During that year, bonus depreciation is not allowed on $50,000 of specified plant costs, but is allowed on the remaining $575,000 of capitalized pre-productive costs, because he may claim bonus depreciation only once on the specified plant.

With the second alternative, bonus depreciation is claimed (at least in part) two times (in the year of planting and on the capitalized costs in the year placed in service).  That may be too much of a stretch for the IRS in terms of interpreting the Code provision at issue and may not be the ultimate result (assuming that IRS does issue some guidance on the matter).

If Gary did not make the election, he would have no deduction in 2016 (giving up a $50,000 deduction) and in 2019, he would place in service $675,000 ($100,000 + $175,000 + $400,000) that would be eligible for 30% bonus depreciation of $202,500.  However, if the first marketable harvest was not until 2020, then not making the election would prevent Gary from deducting any bonus depreciation (however  I.R.C. §179 would still be available).

So, as you can see, timing and planning projections are key to determining the proper position to take on the tax return when starting a vineyard (or other type of business involving “specified plants”).  In addition, taxpayers won’t know exactly how to evaluate their options until IRS clarifies the extent of the costs that are included as part of the “specified plant.” 

Keep in mind also, that this is just a thumbnail sketch of the issue.  There are other issues that space on this blog does not allow us to address. 

Today, I will get into this issue (and others) for a great group of CPAs in Grand Forks, North Dakota.  Next week the farm income tax tour continues in Iowa at Sioux City, West Des Moines (also webcast) and Bettendorf where I will be speaking with Paul Neiffer.