Tuesday, November 26, 2019
On many farms and ranches, windbreaks are used to minimize soil erosion and protect buildings and structures. But, is a windbreak depreciable, or must its cost be capitalized and added to the basis of the land? A depreciation deduction provides an immediate tax break, but adding the cost of a windbreak to the land basis is only beneficial upon eventual sale of the land.
Depreciating or capitalizing windbreaks – it’s the topic of today’s post.
Depreciation applies to property that is either tangible personal property (or is a certain type of real property) that is used in the taxpayer’s trade or business or for the production of income and has a determinable useful life of more than a year. The depreciation rules have changed over the years, with the present system known as the Modified Cost Recovery System (MACRS). MACRS is eight-class system that allows the cost of an asset to be depreciated or recovered over a period shorter than the asset's useful life. All depreciable property fits into one of the eight depreciation classes with its cost recovered over 3, 5, 7, 10, 15, 20, 27 1/2 or 39 years. Property gets assigned to these eight classes either by Congressional legislation or by the IRS. For example, breeding hogs are classified as three-year property. The five and seven-year categories apply generally to farm machinery and equipment. Single-purpose ag and horticultural structures along with trees and vines that produce nuts and fruits are also classified as ten-year property. The 15-year category includes land improvements, including irrigation systems (at least the below-ground part such as wells) and some landscaping costs.
What About Earthen Improvements?
Earthen improvements are generally not depreciable unless the taxpayer can establish that the earthen improvement is physically deteriorating and that, without maintenance, the improvement would become worthless. See, e.g., Ekberg v. United States, No 711 W.D., 1959 U.S. Dist. LEXIS 4467 (D. S.D. Dec. 31, 1959). In addition, expenses for maintaining such improvements should be deductible as repairs. Common items on a farm that are included in the “land improvement” category include silage bunkers, concrete ditches, waterways, pond outlets and wells used for irrigation and livestock watering. Relatedly, a permanent pasture (natural or seeded grassland that remains unplowed for many years) has been held to be depreciable. See, e.g., Johnson v. Westover, No. 16527-WM, 1959 U.S. Dist. LEXIS 4249 (S.D. Cal. Mar. 19, 1955). 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.
But, what about a windbreak on a farm or a ranch? Isn’t a windbreak an earthen improvement that is used in a farmer or rancher’s business? As noted above, they are panted to reduce moisture evaporation and soil erosion. Clearly, trees and vines that produce nuts and fruits are depreciable as ten-year property. However, there is no specific MACRS category for trees (and bushes) planted as a windbreak that don’t also produce nuts and fruits. In Everson v. United States, 108 F.3d 234 (9th Cir. 1997), the court ruled that the windbreak trees and bushes (Russian olive trees and Caragana bushes) that were planted in rows perpendicular to the wind by a prior owner of a 3,700-acre wheat farm were, in essence, part of the land and not depreciable because land does not have a determinable useful life – it doesn’t wear out (in theory). See also, Blair v. Comr., 29 T.C. 1205 (1958). The taxpayer couldn’t establish that the windbreak had a limited life or was associated with a depreciable asset. In addition, the court noted that windbreaks are specifically listed in the definition of non-depreciable soil and water conservation expenses eligible for a deduction under I.R.C. §175. If windbreaks were held to be depreciable, the court reasoned, the specific inclusion of windbreaks in I.R.C. §175(c) as a non-depreciable land improvement eligible for a deduction as a soil and water conservation expense would be rendered meaningless. Thus, because the prior owner of the farm that incurred the cost of planting the windbreak could have deducted the cost of establishing the windbreak under I.R.C. §175, the taxpayer could not allocate part of the purchase price of the ranch to the windbreak and claim a depreciation deduction.
More on Soil and Water Conservation Expense Deductibility
Soil and water conservation expenses that qualify under I.R.C. §175 must be paid or incurred for soil or water conservation purposes with respect to land used in farming, or for the prevention of erosion on farmland and be consistent with a soil conservation plan or an endangered species recovery plan. I.R.C. §§175(a); (c)(3)(A)(i). Qualified expenses include various types of earth moving on farmland using in the business of farming (to produce crops, fruits or other ag products or the sustenance of livestock). I.R.C. §175(c)(2). Expenses for leveling, conditioning, grading, terracing and contour furrowing are all eligible as are costs associated with the control and protection of diversion channels, drainage ditches, irrigation ditches, earthen dams, water courses, outlets and ponds. Even the cost of eradicating brush and, as noted above, the planting of windbreaks is eligible. I.R.C. §175(c)(1). Also included are drainage district assessments (and soil and water conservation district assessments) if such assessments would have been a deductible expense if the taxpayer had paid them directly. I.R.C. §175 (c)(1)(B).
The IRS position is that windbreaks are inextricably associated with the land. As such, the cost of a windbreak is to be added to the basis in the land. In addition, a windbreak is specifically listed under I.R.C. §175 as a non-depreciable item the cost of which is eligible for deduction as a soil and water conservation expense. An “organic” land improvement can be depreciated, however, when the taxpayer can prove that it wears out, or when it is associated with a depreciable asset in such a way that the land improvement is no longer useful to the taxpayer once the asset with which it is associated has completed its useful life. For example, in Rudolph Investment Corp. v. Comr., T.C. Memo. 1972-129, the court allowed the taxpayer to depreciate earthen dams and earthen water storage tanks located on ranchland. The taxpayer was able to establish that, as the result of erosion processes, the dams and storage tanks became filled-in over a period of approximately ten years, so that at the end of the ten-year period they ceased to have any ranch value. In Everson, the taxpayer couldn’t establish a comparable situation for the windbreak.