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June 2011 Archive for The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

Ethanol Industry Will Remain Vibrant With Out Tax Credit

Jun 23, 2011

Todd Becker, CEO of Omaha-based ethanol producer Green Plains, says ethanol "is still a great fuel" according to an article in the Omaha World-Herald.

Ethanol allows for a reduction in demand for foreign oil and is a cleaner burning fuel.  At current production rates, ethanol provides more motor fuel for the United States than it imports from Saudia Arabia, the equivalent of about 1 million barrels a day.

Also, the ethanol industry is more mature than when the tax credit subsidy was originally placed into service and ethanol now actually costs about 30 cents cheaper than gas.  This difference would be reduce by eliminating the 45 cent per gallon credit, but it would not have a dramatic effect on the industry.

This is especially true due to the mandate to blend 12.6 billion gallons of ethanol into gasoline this year.  As long as that mandate remains, ethanol should remain a vibrant industry and the Obama industry stands behind it so far.

The ethanol industry would like to see the elimination of the tax credit (since it really goes to the oil industry, not the ethanol industry) and have the savings put into infrastructure to deliver an 85/15 blend to consumers. 

Major changes to the tax structure of the ethanol industry will most likely happen this year.  It will be interesting to see what the final change will be.

Question on What is a Hedge?

Jun 22, 2011

We had a reader ask the following question:

“On taxing options, you state that hedges apply to crops that you raise or feed. However, you say if you raise wheat but have no livestock an option would not be a hedge. I am confused. “

The tax definition of hedging is when a farmer has made a transaction to minimize or eliminate the risk of price action going against them.  For example, a wheat farmer may purchase a contract on the futures market to sell short their wheat at $7 per bushel.  This contract has locked in the price that the farmer will receive (subject to basis adjustments).  By entering into this contract, if the price of wheat goes up a $1 at the elevator, the farmer will get cash of $8 per bushel but lose $1 on the futures contract for a net of $7.  This is what the IRS calls a hedge.

Conversely, if a farmer only raises livestock and purchases a long contract to buy corn at $5 per bushel, they have hedged their feed costs by locking in corn at $5 per bushel (again subject to basis adjustments).

However, if a wheat farmer with no livestock operation, buys a long contract or a call option to purchase wheat at $7 per bushel, the IRS views this as not being a hedge, but rather speculation on where the price of wheat is headed.  In this case, the gain or loss on the sale of this contract is considered 60% long-term and 40% short-term.  If the farmer has a gain, this may work in their favor since 60% of the gain is taxed at a maximum 15% federal rate, however, if the farmer has a loss and no other capital gains, this loss is limited to $3,000 per year until it is fully used up.

This is why it is extremely important for a farmer to know what is a hedge and what is not for tax purposes and how it can affect them.

China Companies Continue to Buy Up Farm Land

Jun 21, 2011

The Wall Street Journal had an article yesterday on how Chinese companies are continuing to invest in South America especially in buying up farm land to feed their people.  Through the twelve month period ended May 31, 2011, the China's investment in Latin America had hit $15.6 billion.

During the last three years, more than 70% of their investments had been in energy and minerals, but farming is attracting more attention. 

This month, China's largest farming company, Heilongjian Beidahuan Nongken Group signed a joint venture with Argentina's Creud SA to buy land and farm soybeans.  Creud SA already controls more than 2.5 million acres of land in Argentina.  Heilongjian had already indicated back in March their intentions to purchase 500 thousand acres of land overseas during this year and Latin America is their primary target area.

They are also spending $1.5 billion to develop about 750 thousand acres of land in Rio Negro Province over a ten year period.  These developments will not be a direct purchase of land, but they will be in control of the production.

With the backing of the Chinese government, we will continue to see this type of investment going forward.

Women Own 47% of Iowa Farm Land

Jun 19, 2011

I noticed a post on the Iowa Farm Union that indicated 47% of the farm land in Iowa is owned by women. I think this trend will continue and there may be a good chance that this percentage may be in excess of 50% at some point in the near future. Women appear to express a desire for strong conservation in their stewardship of the land, but sometimes are not sure how to most effectively carry this out. The Iowa Farm Union and other state organizations have several seminars devoted to this effort.

As a tenant farmer are you taking advantage of the differences between what is most important to men or women who own farm land. What is most important to male land owners may not be most important to female land owners. By knowing and understanding these differences, you can become a more effective farmer.

Golf Course Falls Victim to High Grain Prices

Jun 16, 2011

The new owner of the Whittemore Golf Course in Algona, Iowa has plowed it under to put in a corn crop for this year.  This nine hole course was originally built in 1969.  The new buyer decided that it would make more money as a farm than as a golf course.

This has caused some rift in the community since they now have lost their local course.  Here is an article on the change over.

I have a feeling that we might start to see more of this happen in smaller corn belt cities if corn and bean prices stay high and the golf participation continues to decrease.

Supreme Court To Decide Tax Spat Between Circuit Courts

Jun 16, 2011

The Supreme Court has decided to hear a case involving a dispute between the Ninth Circuit on one side and the Eighth and Tenth Circuit on the other side concerning the issue of who owes the tax on the capital gains arising from a Chapter 12 farm bankruptcy.

In most normal bankruptcies, the capital gain from selling the estate's assets is generally treated like an unsecured claim and if there are assets available, they are used to pay the income taxes in the same pro-rata basis as all other unsecured claims.  So, in most cases, the IRS will only get pennies on the dollar from the sale of these assets.

However, the rules concerning family farm bankruptcies under Chapter 12 of the bankruptcy Code are a little more unsettled and the Ninth Court feels that these income taxes should be treated as an administrative expense and thus have priority over almost all other claims.  This means that if there is not enough assets in the estate, the claim will usually pass through to the farmer after bankruptcy.  This results in an extra liability to the farmer that they are not expecting.

Therefore, since these three Courts disagree, the Supreme Court has decided to hear this case and make a ruling.  I would expect this ruling in the next few months.  I would expect the ruling to go in the favor of the farmers, but who really knows.

When Are My Agricultural Options Taxed?

Jun 16, 2011

We had a reader ask the following question:

"I am looking at options to put floor prices in for my corn and soybeans. I have a few questions on the accounting for income taxes. Is the cost of options an expense for income tax the year you buy them? If you sell the option the following year, are the proceeds from the option taxable in the year sold?"

The tax treatment of options on futures such as corn, soybeans, wheat, cattle contracts are treated in a unique manner compared to other investments. The taxation of these types of contracts is spelled out in Sections 1092 and 1256 of the Tax Code. This section was put into place to prevent taxpayers from entering into two futures positions that completely offset the risk. The taxpayer would sell the one with loss at the end of the year and then sell the other one the following year. Congress felt this was being abused.

Under this section, all futures contracts including options on futures (except those treated as hedges) are reported at the end of the year as if they were sold for fair market value. So to answer our reader's question, the cost of the option is not recognized when purchased, but the value of the option at year-end is compared to the cost of the option and the difference is considered to be gain or loss.

For example, assume the farmer purchased a call option of 5,000 bushels of corn for $5,000. At the end of the year, the option is worth $10,000. The farmer has a $5,000 gain that will be recognized that year. If next year, when the farmer sells the option for $7,500, the farmer recognizes a $2,500 loss in that year. The total gain was $2,500, but $5,000 was reported the first year and loss of $2,500 was reported the second year.

If this is not a hedging transaction, the gain is automatically treated as 60% long-term and 40% short-term. The above rules don’t apply if the farmer uses this as a hedge . Because of the offsetting positions, Section 1092 applies. Section 1092 delays the reporting of a loss until the year in which gain is recognized on offsetting positions.

Remember, even if you are a farmer and you think all of your futures transactions are hedges, this only applies to crops that you raise or feed. For example, if you grow corn and beans, an option contract for these two crops would be a hedge, but if you purchase or sell an option on wheat or cotton, these are speculative investments and the 60/40 long-term/short-term gain or loss rule applies. Likewise, if you raise wheat (and have no livestock), an option to purchase wheat would not be a hedge.

Get Cash in 2011, Pay Tax in 2013

Jun 15, 2011

With the rapid increase in farm land prices over the last year or so, many farmers are now considering selling some farm land to lock in these high prices.  The Tax Code allows a farmer to reinvest the proceeds from this sale into other real estate using a tax-deferred exchange under Section 1031 (commonly known as a 1031 exchange). 

Generally, the farmer has 45 days after the closing of the sale to identify the property they want to buy (usually 3 can be identified without any risk) and then another 135 days to actually purchase the property, or 180 days in total.

As we approach the beginning of July, farmers have another option using a 1031 exchange that is not available for sales before that date.  This option allows the farmer to receive cash from the sale (actually it must be held by a third party accommodator), but not report the gain until 2012 and pay the tax in 2013.

Here’s how it works. For any sale that happens after approximately July 5 has 180 days to identify and close on the purchase of the new property.  This 180 day period ends in January of 2012.If the farmer is unable to actually purchase replacement property during this time period, the installment sale rules determine when the gain is reported.  Under these rules, as long as the farmer had properly identified the replacement property and has been unable to purchase this property AND the cash is not received by the farmer until 2012, the gain is taxable in 2012 and the tax is due on April 15, 2013 (or March 1, 2013 under the applicable estimated tax rules).

This is a method to allow farmers to actually lock in the price, get the cash into an interest bearing account and defer the tax for an additional tax year.  This can be complicated and  involve a qualified accommodator to handle this type of transaction.  But deferring the tax on a $1 million-plus gain for another year may be worth the extra work involved.

Tools to Help You Make a Decision on What to Plant

Jun 13, 2011

With the late harvest in Ohio and other areas affected by all of the heavy rain and bad planting weather, many farmers face crucial decisions on what crops to plant.  Should they take a risk on planting corn, switch to soybeans or collect insurance on prevented-planting acreage.

You can check out these tools to help you in that decision.  Ohio State University has a spreadsheet to help you with your decision and the Iowa State University has an article comparing likely receipts from late-planted crops versus cash from receiving prevented-planting insurance.

How Does Depreciation Recapture Work?

Jun 07, 2011

We got the following question from one of our readers:

"When does depreciation recapture on equipment kick in? For example a 20 year old tractor fully depreciated sells for $30,000 cash. It cost $50,000 new. Is any of the $30,000 considered a capital gain?"


This is a fairly common transaction for many farmers during their farm career.  Let's take the example that was part of the question and break it down.

When, the tractor is purchased for $50,000, this is the basis that is used for depreciation purposes.  In this case, the tractor was fully depreciated and sold for $30,000.  Depreciation is recaptured up to the amount of "total depreciation taken".  So, in this case, all of the gain is depreciation recapture since the sales price of $30,000 is less than the total depreciation of $50,000.  Another way to look at it is if the the sales price is less than original cost, then all of the gain will always be depreciation recapture.

If the tractor had sold for $70,000, then there would have been depreciation recapture of $50,000 and Section 1231 gain of $20,000.  This gain is usually taxed as long-term capital gains, however, if during the last five years, you had accumulated Section 1231 losses, then part of this gain would be taxed as ordinary income.

In the example, the farmer sold the tractor for cash.  Let's assume the farmer sold the tractor to a neighbor for $5,000 down and the remainder on a five year note.  Since all of the gain is depreciation recapture, the full gain on $30,000 is reported in the year of sale, even though the farmer only got $5,000 of cash.

2011 Capital Gains Tax Rates

Jun 06, 2011

We seem to be getting a lot of requests or searches on what the capital gains tax rate is for 2011.

In summary, capital gains and qualified dividend tax rates are as follows:
  • Short-term (assets held less than a year) are treated as ordinary income.  This means that the maximum tax rate will be the same as your current top marginal tax bracket which can be as high as 35%.
  • The depreciation recapture on equipment is also considered to be ordinary income.  This income is taxed in the year of sale even if no cash is received.  This can trip up farmers when they retire if they are not careful.  The top rate on depreciation recapture for the sale of real estate is 25%.
  • For assets held for more than one year, the top capital gains tax rate is 15%.  If the farmer is in the 15% income tax bracket or lower, than the capital gains tax rate is zero.  This special rate only applies to the amount of the gain that is within this 15% tax bracket.  For example, if the 15% tax bracket ends at $70,000 and the farmer has other taxable income of $45,000 and a net long-term capital gain of $100,000, $25,000 would be taxed at zero and the remaining $75,000 taxed at 15%.
  • Remember, that qualified dividends from a C corporation are also subject to this special lower tax rate.  If you have retained earnings in a C corp, this year and next would be a great time to considered distributing those earnings and not paying more than 15% tax on the dividend.
These are all federal tax rates.  Most states tax capital gains and dividends as regular income, however, certain states may have reduced rates for capital gains.  Please make sure to check with your tax advisor for your local state tax rules.

Tidbits From the Kansas City Fed - Part 2

Jun 02, 2011

Following our theme of providing tidbits from the Kansas City Fed Report:

  • Milk producers have had at least three plus years of unprofitable operations.  The Fed estimated that the average US dairy lost $4 dollars per hundredweight in 2006, made about 50 cents in 2007 and the lost $11, $7 and $4 for 2008-2010.  On average, California dairy farmers (the largest producer in the country) is about $3-$5 better on average and Wisconsin farmers are a little worse than the averages.
  • A lot of the pain in the dairy industry has a direct correlation to US dairy exports.  These exports were steadily climbing until early 2008, when the fell off a cliff.  They had peaked out at about $400 million in 2008, dropped to slightly less than $200 in 2009 and have now finally gotten back to the 2008 levels.
  • Even though times appear to be good for farmers, commercial bankers are reporting the highest level of non-performing loans for farmers since the early 1990's.  After bottoming out in early 2008 at about one-half of one percent of total loans being non-performing, this percentage is now up to about 3% or a five-fold increase.
  • The Fed predicted what would happen to farm land prices if corn prices were to fall from current levels and stay there.  Using a base line of Eastern Nebraska irrigated corn land at $5,000 per acre (which may be low now), that if corn was at $5 per bushel, prices would drop 29%, at $4, drop 43% and at $4, drop 57%.  Also, this is assuming a capitalized value at 7%.  If this number goes up with an increase in interest rates, the price would drop even further.

Tidbits From the Kansas City Fed - Part 1

Jun 01, 2011

As many of our readers know, we tend to quote the Kansas City Federal Reserve from time to time.  They have a very good website with several quarterly reviews of the ag economy and farm land prices.  They recently put out a report titled "Outlook for the Rural Economy" that has several interesting tidbits that I will share in a couple of posts over the next few days.

Although farm income is higher than it was several years ago, it has been on a little bit of a roller coaster ride.  From 2005 to 2011, the net change from the year before is as follows:
  • 2005 - Negative 12%
  • 2006 - Negative 29%
  • 2007 - Positive 20%
  • 2008 - Positive 21%
  • 2009 - Negative 30%
  • 2010 - Positive 25%
  • 2011 - Positive 16%
As you can see, over the last seven years, farm incomes have increased in four of the years and decreased in three of the years.  The total net decrease is about 71% and the total net income is about 82%.
All of the four major Federal Reserve surveys of farm land prices from the fourth quarter of 2009 to the fourth quarter of 2010 showed a healthy increase in prices.  Southern US areas such as Texas and Oklahoma only saw about a 5% increase.  This is probably primarily due to the drought in these areas.  The core corn belt states all saw prices increases greater than 10% as follows:
  • Illinois - 11%
  • Iowa - 18%
  • Nebraska - 17.6%
  • Kansas - 19.5%
  • Minnesota - 19.3%
  • South Dakota - 9.8%
  • North Dakota - 23.7%
Another interesting contrast is the amount of household expenditure that is spent on food by certain countries.  The USA is blessed with only about 7% of the average household having to spend their income on food.  In Pakistan this number is closer to 46% and most of the middle east countries spend at least 40% or more on food.  This is probably one of the key reasons for the turmoil in the area.
This is just a couple of tidbits.  I will have more in the next few days.
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