One of the largest deductions for farmers is depreciation, which can be misunderstood in how it works. The tax code allows you to deduct your farm purchases in three ways in the following order:
- Section 179
- Bonus depreciation
- Regular depreciation
Section 179 allows a farmer to fully deduct up to $1.16 million (in 2023) if the farmer has not bought more than $2.89 million of assets. If you go over that number, you must reduce your deduction dollar-for-dollar.
The maximum Section 179 deduction is equal to your net farm income plus any wages and other certain income. Excess is carried forward to the following year and can be deducted against farm income in that year. This can be beneficial because this will reduce self-employment income.
Not all farm assets qualify for Section 179. For example, farm buildings do not. Almost all other farm assets will qualify.
WHEN TO USE BONUS
Bonus depreciation is allowed on all farm assets other than land. It does not matter if the asset is new or used. Bonus depreciation can cause a net operating loss (NOL), which can then be carried back two years or carried forward.
However, NOLs might not have as much value to you as a Section 179 carryover because it does not reduce self-employment tax. Additionally, you can only offset up to 80% of your taxable income.
Also, a farmer can elect out of bonus depreciation on a class life basis. For example, assume a farmer bought a new combine (five-year life) for $500,000 and a used tractor (seven-year life) for $250,000.
The farmer can elect out of bonus on either the new tractor or combine and depreciate that asset.
FACTOR IN AGE
Finally, if there is any cost basis left, the farmer then depreciates the asset over the class life. Technically, you add one year to the life because the asset is assumed to be in service halfway through the year.
For example, a five-year asset is depreciated over six years. New equipment is depreciated over five years, and used farm equipment must be depreciated over seven years.
Note you can only deduct 80% using bonus depreciation in 2023, and that drops 20% each year thereafter.
Depreciation is a great deduction, and now you know how it works.
