Thursday, November 17, 2016
Now that fall is here it’s time for “hoops” season. Hoops means one thing when it comes to the hardwood, but it can mean something else on the farm or ranch. A “hoop structure” is basically a shelter that can house livestock (swine, cattle, sheep, goats and horses), but it can also be used to store hay and/or machinery. If used for storage, they are an alternative to the more traditional pole barn.
A hoop structure is built with steel arches that are mounted on wood or concrete sidewalls. The steel arches are securely fastened to the sidewall to transmit the wind forces to the sidewalls and the ground. They can be used for numerous purposes. If the structure is used for livestock, then a feed bunk is placed outside the sidewall. Putting the feed bunk outside the sidewall eliminates and need of an interior drive path. Also, in this situation, an overhang is added to reduce the rainwater entering the bunk. A polyethylene fabric tarp is stretched over the steel framing to form the roof of the structure, and the tarp is designed to reflect solar radiation to prevent heat stress. Lighting is not necessarily utilized. The structure is either installed directly on the ground or on concrete or wooden walls. A hoop structure can also be used to store ag commodities or machinery.
What are the tax implications of a hoop structure? How is it classified for depreciation purposes? Is it eligible for expense method depreciation under I.R.C. §179? Is it eligible for first-year bonus depreciation?
These are issues that myself and Chris Hesse and Paul Neiffer of CLA kicked around earlier this year. Today’s blog post takes a look at these issues.
Depreciation Recovery Period
Without a doubt a hoop structure is farm real property. Farm real property can be classified at least four ways (in accordance with Rev. Proc. 87-56):
- A land improvement (class 00.3) has a cost recovery period of 15 years.
- A single purpose agricultural or horticultural structure (class 01.4) has a cost recovery period of 10 years.
- I.R.C. §1245 real property with no class life has a cost recovery of seven years.
- A farm building (class 01.3) has a cost recovery period of 20 years.
A land improvement is an item that is added directly to land and is either I.R.C. §1245 or I.R.C. §1250 property if it is depreciable. Fences, landscaping, roads, sidewalks, canals and waterways fit in this category under Rev. Proc. 87-56. Also, included in this category are silage bunkers, concrete ditches, wasteways and pond outlets as well as irrigation and livestock watering wells. None of these look like buildings. Thus, a hoop structure would not fit in this category.
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 I.R.C. §38 (investment tax credit). Tax legislation in 1986 moved that language into I.R.C. §1245 for depreciation recapture purposes. Under that definition, a single purpose ag structure is used for housing, raising and feeding a particular type of livestock and their produce, and the housing of the necessary equipment. I.R.C. §48(p)(2). 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. A hoop structure is not a single purpose structure and doesn’t fit in this category. It can house various types of livestock, and store commodities and/or machinery. If you have any doubt, a flat storage building has been held not to be a single purpose agricultural or horticultural structure. Bundy v. United States, 59 AFTR 2d 87-682 (1986). A flat storage building is pretty much the same as a hoop structure – not a single purpose ag or horticultural structure.
Assets that look like 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). These assets are, basically, machinery and equipment which are an integral part of manufacturing or production. I.R.C. §1245(a)(3)(B)(i). This category includes storage facilities for potatoes, onions and other cold storage facilities for fruits and vegetables. If the asset is used for other purposes after the commodities have been removed, the structures are buildings, rather than I.R.C. §1245 property. So, if the property is easily adaptable to other uses, it is a building and not I.R.C.§1245 real property. But, if the property is specially designed and unsuitable for other uses, it is not a building. Olson v. Comr., T.C. Memo. 1970-296 (1970). It really comes down to what “easily adaptable” means. That is determined on a case-by-case basis based on the economical cost of the structure in of each situation. Whether a hoop structure fits in this category either depends on each particular situation.
A farm building, then, by default, is a real property item that is not included in another class. Such things as shops, machine sheds and other general purpose buildings on a farm that are not integral to the manufacturing, production or growing process are included in this category. Hoop structures generally fit in this category and would have a cost recovery period of 20 years. They are 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.
Assets that are used in the farming business (as defined in I.R.C. §168(b)(2)(B)) must use the 150 percent declining balance method rather than the 200 percent declining balance method. It is the business of the taxpayer that controls the method available for depreciation, rather than the function of the equipment in the business.
Expense Method Depreciation
To be eligible for expense method depreciation (I.R.C. §179), property must be acquired by purchase, used more than 50 percent in the active conduct of a trade or business, and be I.R.C. §1245 property that is either MACRS property or off-the-shelf computer software. We have already established the general rule that a hoop structure is a general purpose ag building that is not I.R.C. §1245 real property. Thus, under the general rule, a hoop structure is not eligible for I.R.C. §179 depreciation unless it is not a building and is an integral part of production like fences, and drainage tile, machinery and equipment, etc., or is akin to a bulk storage facility. But, if the argument is that they qualify as a storage facility, the argument is a tough one to make because of the hoop structure’s ability to be adapted to different uses. If such adaptation is economically reasonable, and the structure provides working space in addition to storage space, a hoop structure won’t qualify as bulk storage. See Brown & Williamson Tobacco Corporation v. United States, 369 F. Supp. 1283 (W.D. Ky. 1973). So, the IRS view is likely to be that a hoop structure is a general purpose ag building that is not eligible for I.R.C. §179. The facts of an individual situation might change that conclusion, however.
In general, property that is eligible for first year “bonus” depreciation (set at the 50 percent level for 2016) must have its original use commence with the taxpayer, be tangible depreciable property with a MACRS recovery period of 20 years or less and not be “excepted” property (basically, property that is not placed in service and disposed of in the same tax year or be converted from business to personal use in the tax year that it was acquired). A hoop structure would meet the test if its original use commenced with the taxpayer and it is not excepted property (unlikely). Unless an election out of bonus depreciation is made, it is claimed before any applicable MACRS depreciation is claimed.
Hoop structures have been gaining in popularity in recent years due to their economic efficiency and utility. But, they present some tricky tax issues primarily associated with depreciation. That’s because of their less than permanent character, and the lack of specific guidance from the IRS. Fitting them within the existing framework for agricultural assets leads to the likely IRS conclusion that they are a general purpose farm building with a cost recovery period of 20 years, ineligible for I.R.C. §179 and potentially eligible for first-year “bonus” depreciation. But, the facts of a particular situation could result in a hoop structure being determined to be I.R.C. §1245 real property with no class life that qualifies for I.R.C. §179 and is potentially eligible for first-year “bonus” depreciation.