Taxlink

Farming is a capital-intensive business. With high land prices, the astronomical cost of equipment and the ever-increasing cost of crop inputs, debt is a necessary evil. During the past few years, high interest rates have made the cost of borrowing a significant burden. Sometimes, the tax consequences of debt are not that clear and farmers can get caught with an unexpected tax burden. Let's take a look at a few tax-related items associated with debt.

When you take on debt, you can deduct interest paid. However, there is a limitation on how much interest expense is allowed. You can deduct interest up to 30% of your adjusted taxable income. Under the Tax Cuts and Jobs Act (TCJA), adjusted taxable income included an expense for depreciation and amortization. As you know, depreciation is often one of the largest expenses. As a result, heavily leveraged farm operations sometimes had disallowed interest expense. This was changed under the new tax bill. Starting in 2025, depreciation and amortization expense are not included in adjusted taxable income (ATI) -- it's now more like earnings before interest, taxes, depreciation and amortization. Although this is a positive change, heavily leveraged farming operations still could face disallowed interest expense.

If debt is canceled, you will have cancellation of debt income. In general, the amount of debt that is deemed canceled is treated as ordinary income. If the debt was secured by property, and the lender takes back the property, you are deemed to have sold the property back to the lender. The tax treatment depends on the type of debt used to secure the property. If the property was subject to recourse debt, the amount realized is the fair market value of the property, and the ordinary income component from cancellation of debt is the amount of debt forgiven in excess of the fair market value of the property. For nonrecourse, the amount realized is the entire nonrecourse debt plus the amount of cash and/or fair market value of property received.

There are certain exclusions that result in cancellation of debt not treated as gross income. This includes Title 11 bankruptcy, insolvency, cancellation of qualified farm debt and cancellation of qualified real property business debt. If one of these exclusions apply, you still must reduce certain tax attributes by the amount excluded.

I'd like to quickly touch upon the qualified farm debt exclusion, which applies to debt canceled related to farming when the farmer derived 50% or more of gross receipts from the trade or business of farming for a period of three years prior to the cancellation of debt. The debt has to be canceled by a "qualified" person. A qualified person can't be a related party, someone you purchased the property from, or a person who received a fee with respect to the investment in the property.

Although leasing isn't debt, farmers often treat it as a substitute. For example: capital or operating leases. A capital lease is where you lease an asset, but it's essentially treated as a purchase. The lessee (farmer) gets to depreciate the leased asset. An operating lease is where the lessor retains ownership, risk and benefits of the asset. The lessor gets to deprecate the asset, not the farmer (one way to get a lower interest rate). I can write a whole paper on the differences, but essentially, if the asset is transferred at the end of the lease, or the purchase option is such that the lessee almost certainly will buy the asset, it's a capital lease.

As you can see, debt can trigger tax issues. Before you enter a lease or modify debt, talk to your tax professional. It might save you from a nasty surprise come tax time.

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DTN Tax Columnist Rod Mauszycki, J.D., MBT, is a tax principal with CLA (CliftonLarsonAllen) in Minneapolis, Minnesota. Read Rod's "Ask the Taxman" column at https://www.dtnpf.com/…. You may email Rod at taxman@dtn.com.

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