Be Careful with De-minimis Election with Breeding Stock

Published on: 17:24PM Dec 06, 2015

We mentioned in a previous post that the IRS has updated the de-minimis election to allow farmers and ranchers to deduct all items costing less than $2,500 on their income tax return.  This is an annual election and most farmers will make the election.  This allows them to deduct all items costing less than $2,500 without having to use Section 179, bonus depreciation or depreciate the item.

However, there is one draw-back to using this election.  Any sale of the item is subject to ordinary income tax on all gross proceeds which may result in greater tax than setting the items up on a depreciation schedule and taking depreciation or Section 179.  This can be especially true for purchases of items that a rancher or farmer expect to appreciate in value over time (perhaps purchased young breeding stock).

As an example, suppose a rancher purchases 100 new springer heifers to be used for breeding purchases.  The rancher spends a total of $125,000 on the heifers.  If the farmers makes the de-minimis election, he can deduct all $125,000 in the current year (even if Section 179 remains at $500,000).  Five years later, the rancher sells these cows for $250,000.  Since he made the election to deduct in year of purchase, all $250,000 is subject to ordinary income tax rates.  However, if the farmer did not make the election, he could depreciate the cattle and in the year of sale, the gain associated with depreciation recapture (maximum amount $125,000) would be subject to ordinary tax rates, with the remaining $125,000 likely being taxed at capital gains tax rates.  Assuming a 35% tax rate for the rancher, the tax savings would be $25,000 ($125,000 X (35%-15%)).

Therefore, any time a farmer or rancher makes a lot of purchases costing less than $2,500 in any tax year, care must be taken to review whether the de-minimis election should be made if it is likely the assets will appreciate in value.