Ask the Taxman by Andy Biebl

DTN Tax Columnist Andy Biebl is a CPA and tax partner with the accounting firm of CliftonLarsonAllen in Minneapolis, Minn., and a national authority on agricultural taxation. To pose questions for upcoming columns, email AskAndy@telventdtn.com. For in-depth case studies on farm estate, transition and retirement planning, subscribe to Andy's two-hour webinar, "Pass It On!" To subscribe, go to http://www.dtn.com/…

Question:

We bought a farm in 2012. It has terraces, tiles, and risers. I understand that we can depreciate the cost of the tiling and the risers. But can we take the cost of trenching for the tiling, the bulldozing for building the terraces, and the cost of building waterways? These additional costs would be for projects already completed that were on the farm at purchase.

Answer:

In general, depreciable property must consist of tangible assets, not earthen improvements. Your drain tile and risers are depreciable, as they consist of masonry, concrete, or other plastic/synthetic material. And when a taxpayer installs these types of improvements, the cost of excavating or other machine and labor costs related to the installation become part of the basis of the depreciable improvement. In your case, the tiling and risers need to be assigned a fair market value based on current age and condition, and that part of your land purchase becomes depreciable.

But with respect to the terracing and waterways that are part of your land purchase, those earthen improvements are part of the nondepreciable basis in the land. However, when a farmer originally creates terracing or waterways, it is possible that a deduction can be secured under the special soil and water conservation rules of Section 175. The primary test is that the conservation improvements must be under a specific USDA/FSA plan or under a general county-wide approved plan for soil and water conservation. The IRS Publication 225, "Farmers Tax Guide," has an entire chapter devoted to the soil and water conservation deduction opportunity. Go to http://www.irs.gov/… for details.

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Question:

In addition to crop income, I have income from the Conservation Reserve Program. I understand that CRP income can be excluded from self-employment tax. Does this also remove it from earned income as it relates to income that can be placed in a Roth IRA or other retirement plan?

Answer:

The direct answer to your question is easy: If CRP is treated as earned income subject to SE tax, it qualifies for funding a retirement plan, including a Roth IRA. On the other hand, if it is treated as rental income not subject to self-employment tax, it would not meet the definition of earned income for funding a retirement plan.

The bigger issue, however, is your assumption that CRP can be excluded from self-employment tax. The tax law is somewhat of a mess on this point in its current state. The only real clarity relates to one group of taxpayers, thanks to a provision added by Congress in 2008. Individuals receiving Social Security retirement or disability benefits are exempt from the payment of SE tax on any CRP income, effective for payments made after 2007.

But for those not collecting Social Security benefits, the law is more muddled. In the Wuebker decision, the Sixth Circuit ruled that an active farmer who placed some land in CRP still had an active business connection to the CRP income and was subject to SE tax. However, this opinion conflicted with the earlier Tax Court decision for the same taxpayer, which held that CRP was inherently rent from real estate and exempt from SE tax like other real estate rents. If the taxpayer is a landlord with no active farming, CRP should be treated like other rents that are exempt from SE tax. Just remember the IRS has contested that; there is a case currently before the Tax Court on that issue.

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Question:

One of our farms borders a state highway that was recently made wider. After a lot of appraisal fights and some legal tussles, we finally received a settlement check for the acres we lost. My accountant thinks we have several years to reinvest this into other land without paying tax. Is that right?

Answer:

Your accountant is referring to the Section 1033 involuntary conversion provisions. When property is disposed of under a threat of condemnation, as is the case with situations like the state taking your property for a road expansion, the funds that you receive can be reinvested in other real estate on a tax-deferred basis. There are different rules under Section 1033 for different categories of involuntary conversions (such as a fire vs. a real estate condemnation).

In your situation, you have three years from the end of the tax year in which gain on the old property occurs to complete your reinvestment. So if the settlement proceeds from the state were received now in 2013, you have until Dec. 31, 2016 to complete your replacement in order to defer the gain, but you will need an elective statement in your tax return for 2013 to initiate this deferral privilege.

Finally, because of the real estate condemnation status, you may have a broader definition of eligible replacement property than only farm land. If you were renting the land taken for the roadway, the purchase of any other replacement rental real estate, whether land or buildings, even newly constructed buildings on land you already own, would qualify (Rev. Rul. 71-41). But if you are an active farmer, given some uncertainties in the replacement definitions, avoid any replacement into buildings on land you already own.

(MT\SK)

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