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February 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.

Another Reason to Use a LLC Versus a Partnership

Feb 28, 2011

I came across a recent court case regarding the non-discharge of farm debt for a husband and wife in a partnership.  The husband had provided a "borrowing base certificate" to the lender showing the farm owned about 4,700 head of cattle when in reality the farm never had more than 1,000 cattle at any one time.  The debtor wife had argued that she did not participate in the issuance of the borrowing base, therefore, her portion of the debt should be discharged.

The court found that a partnership existed between the debtors in that the wife participated in the financial management of the farm, received distributions, and either had knowledge of the information contained in the borrowing base certificate or should have know what was in it.  Because the debtors were partners, the court imputed the husband's fraud to the wife and held the debt non-dischargeable to both debtors.
This case illustrates another reason to use a limited liability corporation or regular corporation in the operation of your farm.  These types of entities can in most cases prevent the above from happening.  However, to effectively use this as a shield, you must discuss this with your legal advisor.  Also, farm couples should try to shield the non-participating interest in the farm operation by not having that spouse sign personal guarantees when possible.

Dairy Producer Continues Expansion into China

Feb 23, 2011

In yesterday's Wall Street Journal, there was an interview with Andrew Ferrier, the Chief Executive of Fonterra Co-Operative Group of New Zealand.  This company is the third largest dairy exporter in the world with sales of about $13 billion, profits of $500 million and almost 16,000 employees.  It is interesting that a small country like New Zealand is able to have a dairy company that is the third largest dairy exporter and will probably get larger.

Some of the interesting comments from the interview are as follows:
  • Even though the company was hurt by the contaminated milk scandal of 2008, it is pushing ahead to develop many more dairy farms in China.  They have one farm already, are developing a second and have a third in the works.  They also have several joint ventures with other multiple farms.  One of the key issues in having a diary in China is that feed must be brought to the farm.
  • The steady rise in global consumption will continue as developing nations get wealthier, there is a bigger middle class looking for healthier foods.  Many of these are looking to switch from carbohydrate-based diets to a protein-based diet, fueling the need for protein and dairy.
I think we will continue to see other companies attempt to expand their food production capabilities in China and India.  We will see how it goes.

Farmer's Tax Due Date - March 1 or April 15?

Feb 21, 2011

With about 8 days to March 1, most farmers are frantically scrambling to get all of their tax data accumulated and presented to their tax preparers.  Almost all farmers try to file by March 1 since there is no penalty for filing and paying their income tax for the year by that date even if the payment is substantial.

However, I would like to remind our farmers again that if they have paid in enough income tax, either through withholding or estimates to prevent an penalty for underpayment of estimated tax, they do not have to rush to get filed by March 1.  If their tax for the previous year is very low, for example, $2,000 or less, the actual penalty would also be extremely small (based on this $2,000 amount, the penalty might only be about $20 or so.)
Therefore, if you have paid in enough to cover your requirements or your tax for the previous year was very small, do not worry about March 1, just get if filed by April 15 and your life will be easier.

Federal Reserve Reports Rapid Rise in Land Values and Farm Income!

Feb 16, 2011

The Federal Reserve of Kansas City on Tuesday reported that farm land values in their district had risen substantially from the previous year.  The year-over-year rise for non-irrigated land were as follows:

  • Kansas            19.5%
  • Missouri          6.6%
  • Nebraska       17.6%
  • Oklahoma        5.0%
The overall value for their district was a 14.8 percent rise for non-irrigated crop land and 12.9 percent for irrigated.  Rising farm income, especially for crop farmers, drove the prices up almost 20% in Kansas and Nebraska.
Although farmland prices are up sharply, cash rents increased an average of 6% for crop land and 4% for ranch land.
Farm real estate loan-to-value ratios ranged from 50% to 90% with an average of 70%.  Many bankers are now putting a cap on a set dollar per acre that they will loan on.  For example, if the appraised value is $7,500 per acre, the bank may only allow an use of $5,000 per acre to loan against.  This will normally require more of a cash investment by the farmer.
The farm income index soared in the fourth quarter approaching the highs set in 2008.  I saw another article where the USDA is perdicting net farm income for 2011 of about $98 billion .  It would not surprise me that we will go over $100 billion with the continued strong farm commodity prices across the board.

$2 Cotton Can Lead to Bankrupt Farmers!

Feb 15, 2011

Now that cotton is rapidly approaching $2 a pound or corn is over $7 a bushel, many people feel that farmers now have it made and the good times will always be here.  What I have seen in my career is that almost the exact opposite may happen.  Many farmers (or other business people) get a false sense of security that high prices will remain high.  However, we know through out history, high prices always lead to one thing and one thing only - LOW PRICES at some point.

Generally, when prices are high, farmers that get in trouble tend to do the following:
  • Expand their operation by buying high priced land,
  • Expand their machinery base by purchasing more expensive and newer machinery,
  • Defer the sale of their crops to escape the tax man,
  • Expand their personal living lifestyle to include more trips, larger house, etc,
  • Replace liquidity with long-term assets.
Now when prices remain high, almost all of these situations can be handled by the farm operation.  However, when prices start to adjust and if they by chance remain close to their lows for at least two years, any farmer that has done at least three of the above five items will either go bankrupt or have massive liquidity issues to deal with.
As an advisor, I would recommend that a farmer take advantage of these good times by doing almost the exact opposite of what is shown above.  In other words, when prices are very good, a farmer should:
  • Keep their lifestyle the same or even reduce their living expenses,
  • Pay the tax man with these high priced commodities, if you defer it, you will most likely get a lower price and owe no tax,
  • Not covet the neighbor's half-section, but rather wait for the price adjustment and buy it for cash when times are bad,
  • Expand their liquidity to at least 50% of annual sales,
  • Keep their machinery for another year or two
If farmers do a great job of this, they will have substantial more net worth to use to acquire land when the prices adjust. 
Which farmer do you want to be?

Exchange of Bare Land Allows for Depreciation on New Property

Feb 12, 2011

We got the following question from a reader:

"If I 1031 a bare land parcel for a parcel with improvements can I depreciate the improvements?"
Before, I answer the question, lets review what "1031" means.  1031 refers to the section of the Internal Revenue Code dealing with tax-deferred exchanges.  Under a 1031, a farmer can defer the gain on the sale of land by reinvesting the total proceeds into other like-kind real estate. 
Some misconceptions about this is that a lot of taxpayers do not understand that raw farmland is like-kind with other real estate such as apartment buildings, retail strip centers, etc.
Another tricky part of a 1031 exchange is that normally the farmer needs to use a facilitator to handle the exchange during the whole process.  I get many calls through-out the year from my clients saying that they sold a piece of property (without calling me first), got the cash and now want to know how to finish up the exchange so they can defer the gain.  They are too late. 
In order to have a proper 1031 exchange, the farmer must:
  1. Enter into an exchange agreement with the facilitator,
  2. Have the closing proceeds transferred at closing to the facilitator,
  3. Identify the property they want to acquire within 45 days, and
  4. Purchase that property within another 135 days or 180 days total.
There are no extensions on either the 45 day or 180 rule and if you miss any of these steps, you no longer have a qualified exchange.  These rules are complex and you need to review them with your advisor.
For the current question, the rollover of the land into the land with improvements will allow the farmer to allocate their basis partly to the land, which can not be depreciated, and partly to the improvements which can be depreciated.  Normally, this allocation is based upon the fair market value of the improvements over the total sales price times the basis in the property.


Bred Replacement Heifers Qualify for Bonus Depreciation

Feb 09, 2011

We had a reader ask the following question:

"I am new to cattle farming and purchased bred replacement heifers in 2010, can I take the 100% bonus depreciation on them?, as they are "New" (never calved before)? Alternatively, what would be the best type of depreciation method to apply to heifers to maximize my depreciation for 2010 and possibly 2011?"
Heifers that have never delivered a calf before and are newly purchased from a rancher will qualify for bonus depreciation (50% before September 9, 2010 and 100% thereafter until the end of 2011).  The farmer that raised the heifer is sort of like an equipment manufacturer.  The heifer is part of their inventory and once it is ready to be bred, it is now a new heifer ready to be put into use by the cow/calf operator.  It is like the equipment manufacturer building a combine and selling it to the farmer to start harvesting corn.  Thus, the heifer can be depreciated using the bonus depreciation rules in effect based upon the day placed in service (normally the day the heifer was purchased).

Capital Gains Tax Rates for 2011

Feb 08, 2011

We had a reader ask the following question:

"What will be the cap gain tax rates for the year we are now in 2011 specifically by income tax bracket?"
For 2011 and 2012, long-term capital gains (assets held for more than one year) are taxed at a maximum tax rate of 15% (unless you are selling collectibles or have depreciation recapture on real estate, then the maximum rate is 28% and 25% respectively).
Therefore, if you sell land that you have held for more than a year, the maximum federal tax rate on this gain is 15%.  It does not matter if the gain is $50,000 or $5 million, the maximum rate is still 15%.
Now, if you live in a state with state income taxes, you need to add this rate to the 15% federal rate to arrive at your overall effective tax rate.  The state income taxes paid are allowed as a deduction, however, it may be disallowed in arriving at your alternative minimum tax.  You should review this with your tax advisor to pin down your effective rate.  Also, some states allow an additional deduction for the sale of farm land and you need to check this out.
For those farmers in the lower tax bracket, they may have long-term capital gains taxed at zero.  For all capital gains and qualified dividend income in the 15% or lower tax bracket, this part of the gain is taxed at zero.
For example, if you income from farming and all other non-capital gain income creates net taxable income of $20,000, you can have long-term capitals and dividend income of about $50,000 which will be tax free for 2011 and 2012.

Are YOu Ready For The Super Bowl of Farming?

Feb 07, 2011


After watching the Super Bowl last night (and I must admit I was rooting for the Packers), I reflected on how our farmers may want to check their operations and management to see if they would be ready to play in the Super Bowl of Farming.
As a manager of your farm operation are you:
  • Using accrual accounting to determine your true net farm income for each year
  • Taking advantage of precision farming to minimize your input costs and maximize your revenues
  • Using a marketing plan each year for each crop
  • Maximizing your equipment utilization to reduce your overall equipment cost per acre
  • Providing appropriate incentives for your employees
  • Taking advantage of a Web Site to provide information to your landlords, employees and other interested parties
  • Being proactive with you banker by providing information before they ask and keeping them updated
  • Obtaining education each year on how to improve each of the above items.
How is your scorecard on each of these.  Could you play in the Super Bowl of Farming?

Time for a Fiscal Checkup!

Feb 02, 2011

One of the things that struck me about attending both the TEPAP and the Top Producer Conference is how many of our top farmers are still not taking advantage of all of the financial tools available to them.

For example, I would estimate that probably upwards of 90% of all farmers are still using the cash method of accounting to track their farm income and expenses.  For most, this is the method that they use to prepare their income taxes, however, it HARDLY ever gives an accurate picture of overall farm net income.  Ask yourself how much of the expense that you pay at year-end has nothing to do with this year's crop or how much of your crop sales reported in this year was actually harvested in this year.
By using farm accrual accounting on an on-going basis (not simply making some adjustments at year-end), you can accurately determine how much income you generated off of this years crops and know what you really made for the year, not what you show to the tax man.  Some farmers hesitate since they think it will create more work for their accountant/CPA at tax time, however, to convert from accrual to cash for the tax return is usually very easy for a tax preparer to work out.
Since this is the time you are working with your tax advisor, make sure to discuss this with him now.  It is much easier to get switched over at this time of year than in the middle of planting or harvesting.  Once you make the switch, you will never go back.

Remember - Section 179 is an Election!

Feb 01, 2011

We had a reader ask the following question:

"Is there an order in which I have to take depreciation? One of your explanations indicated taking section 179 first then bonus depreciation and then regular depreciation. I am wanting to take the 100% bonus depreciation on all new items and not section 179 due to the fact I would not have to recapture section 179 depreciation if I later traded or sold the asset before the life of the asset ran out. Is there any reason not to take the bonus rather than the section 179? Do I have to make a special election?"

The Section 179 deduction is an election that a farmer makes when filing their tax return each year.  The farmer is not required to take Section 179 on any asset, but rather, has the option to take as much Section 179 on the asset as they want. 

If you purchase a combine for $300,000, you can "elect" to take Section 179 of $1 up to $300,000 (assuming you meet the income limitation and overall asset purchase limitation).

Therefore, in this question, the farmer can make an election to not take the Section 179 on the new assets and simply have 100% bonus depreciation apply on new assets.  However, if it is a used asset, they can only take Section 179 on the asset, 100% bonus depreciation does not apply.  

The election is made on form 4562 where you will list each asset with the name, purchase price, etc. and then how much of the asset you want to take Section 179 on.

Although the farmer will not have Section 179 depreciation recapture on the later sale of the asset, they will still report that same amount of gain on form 4797 whether they took Section 179 on the full asset value or wrote off the asset using 100% bonus depreciation.  It will be reported differently, but the gain will be the same amount.

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