Cost Segregation Study – Do you Need One For Your Farm?

Overview

While farm and ranch land is typically the largest-valued asset for the business, there may be items of significant value associated with the land.  The land is not depreciable, but structures associated with the land are.  From a depreciation standpoint, that means that there may be opportunities to allocate costs to personal property or land improvements that are depreciable.  How is this allocation accomplished?  One approach is to utilize a cost segregation study.

Agricultural cost segregation studies – that’s the topic of today’s post. 

Cost Segregation Study – The Basics

A cost segregation study involves the combination of accounting and engineering concepts and techniques to identify costs associated with buildings and other structures and tangible personal property.  The identification and allocation of costs to these items allows accelerated depreciation deductions to be available with the result that taxes can be reduced and cash flow for the business increased.  Land is not depreciable and farm buildings are depreciated over 20 years. 

When it comes to buildings, often a farmer will allocate the majority (if not all) of the cost of acquiring or constructing a building to real property.  By doing so, the farmer may be overlooking the chance to allocate costs to personal property that has a shorter depreciation period than the 20 years over which a farm building is depreciated, and/or to depreciable land improvements.   For example, the structural components of a building are often depreciable over 5-7 years. This would include such items as walls, windows, HVAC systems, plumbing and wiring.  Land improvements are generally depreciable over 15 years.

For many taxpayers, the focus of a cost segregation study may be exclusively on a building.  This is often the case, for example, for a commercial business.  But, for a farmer, a cost segregation study has a broader application to examine whether depreciable items of personal property aren’t mistakenly lumped in with real property.  As applied to farm buildings, a study will see if such things as parsing out the electrical wiring associated with a dairy parlor or a sow feeding system is possible.  For fruit and vegetable farming operations, specialized equipment might be involved or there might also be some type of cooling system involved for a particular space or structure.  

But, it’s not just buildings that need to be examined when it comes to ag.  The farmland must also be looked at to account for improvements that have been made to the land for farming purposes.   Land is not depreciable, but improvements to the land used in farming can be.  These improvements include such things as pumps and wells that have been installed for irrigation purposes; fences; stock-watering ponds; earthen dams; soil conservation terraces; roads; fences and gates; drainage ditches and; water diversion channels. 

Benefits of a Cost Segregation Study

Why conduct a cost segregation study?  Depending on the situation, the tax savings that will enhance after-tax cash flow could be worth it.  For example, assume that a farm building is acquired along with the purchase of a farm.  If the farm was purchased for $500,000 and 100,000 was allocated to the farm building, that $100,000 would be depreciated over 20 years at five percent annually.  In other words, the taxpayer could claim a $5,000 deduction annually attributable to the building.  But, it may be the case that more of the cost can be allocated to depreciable property with shorter depreciable lives.  If so, the depreciation deductions associated with the building and the items in the building will be enhanced. Breaking items out like this can also make it easier to make a partial asset disposition election and aid in deducting removal costs. 

A “look-back” cost segregation study may also be used to identify missed deductions from prior years.  To claim these deductions Form 3115 (application for a change in accounting method) must be filed with the IRS  to claim these “catch-up” deductions on the current year return without filing amended returns.  This can also be beneficial in certain circumstances in dealing with the limitations on deducting losses under the post-2017 rules.

Breaking out and identifying items that are depreciable personal property from real estate may also have a property tax benefit.  In some states, farm personal property is not taxed for real estate purposes.  Thus, if the items of depreciable personal property are broken out with a value assigned to them, real estate taxes may drop. 

Another potential benefit of a cost segregation study is that it could result in a greater ability to take advantage of certain aspects of the Tax Cuts and Jobs Act (TCJA) of 2017.  Under the TCJA, at least temporarily, first-year bonus depreciation is 100 percent and can apply to both new and used qualified property.  In addition, I.R.C. §179 has been increased to $1,000,000 (and indexed), and the phase-out also increased.  Thus, property that is reclassified into a category that qualifies for either bonus or expense-method depreciation will generate tax savings.  As noted above, there may also be a benefit in dealing with losses.

Conclusion

Is a cost segregation study right for you?  It depends on the situation.  However, it might be worth having the conversation with your tax professional for a determination of whether it would be beneficial in your particular situation.    A cost-segregation study is not cost-free.  So, the question is whether the benefits will outweigh the costs.  It’s just another consideration when it comes to tax planning for the farm or ranch.  Depending on your situation and the type of farming operation that you have, it may be worthwhile.  Have you thought about it?