Expense Method Depreciation and Structures on the Farm

Overview

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.

In General

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. 

Conclusion

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.