Farm businesses that acquired constructed or made substantial improvements to a building — or did so in previous years — should consider a cost segregation study. Also referred to as a “Cost Seg,” these studies combine accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. This may allow you to accelerate depreciation deductions, which can mean reduced taxes and increased cash flow.
IRS rules generally allow you to depreciate farm buildings, such as equipment sheds and barns over 20 years. Most times, you’ll depreciate a building’s structural components — such as walls, windows, HVAC systems, plumbing and wiring — along with the building. Personal property — such as equipment, machinery and furniture are eligible for accelerated depreciation, usually over five or seven years. And land improvements such as fences, outdoor lighting and parking lots are depreciable over 15 years.
Many times farmers allocate all or most of a building’s acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. Often the line between the two isn’t all that clear. Items that appear to be part of a farm building may in fact be personal property, like electrical wiring to dairy parlors or sow feeding systems. Thus, Agricultural Cost Segregation Studies need a broader view. When preparing a Cost Segregation Study for farmers, we need to look at far more than constructed buildings; we must also consider the buildings and farm land itself and all the improvements made to the property for the purposes of farming.
Of course, the land itself cannot be depreciated. But certain site improvements to the land can be: road coverings, for instance, if they’ve been privately built; pumps and wells; fences and gates; irrigation installations; and electrical wiring. And, in some cases, dams, ponds, and terraces. Most of the agricultural cost segregation study possibilities are spelled out clearly in IRS Publication 225, Farmer’s Tax Guide.
Certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business/farm function than a structural purpose. This includes reinforced flooring to support heavy equipment, electrical or plumbing installations required to operate specialized equipment, or dedicated cooling systems for specialty spaces.
Although the relative costs and benefits of a cost segregation study depend on your particular circumstances, it can be a valuable investment. For example, let’s say you acquire a farm building for $1 million on Jan. 1. If the entire purchase price is allocated to 20-year real property, you’re entitled to claim $50,000 (5% of $1 million) in depreciation deductions the first year. A cost segregation study may reveal that you can allocate $250,000 in costs to five-year property eligible for accelerated depreciation. Reallocating the purchase price increases your first-year depreciation deductions to at least $87,500 ($750,000 × 5%, plus $250,000 × 20%).
A cost segregation study can assist you in making partial asset disposition elections and deducting removal costs under the recently issued final tangible property regulations.
If your farm invested in depreciable buildings or improvements in previous years, it’s not too late to take advantage of a cost segregation study. A “look-back” cost segregation study allows you to claim missed deductions dating back to 1987.
To claim these tax benefits, file Form 3115, “Application for Change in Accounting Method,” with the IRS and claim a one-time “catch-up” deduction on your current year’s return. There’s no need to amend previous years’ returns.
You may also use cost segregation studies to support the personal property vs. real estate tax treatment of certain items. Meaning items deemed as personal property items (which are not taxed in Ohio) should not be taxed for real estate tax purposes. You may be able to use the report to be sure your real estate tax bill is appropriately stated, and that certain building components are reclassified as personal property based on a cost segregation study
Cost segregation studies may yield substantial benefits, but they’re not right for every farming business. To find out whether a study would be worthwhile, we would be happy to to do an initial evaluation to assess the potential tax savings.
Brian E. Ravencraft, CPA, CGMA is a Principal with Holbrook & Manter, CPAs. Brian has been with Holbrook & Manter since 1995, primarily focusing on the areas of Tax Consulting and Management Advisory Services within several firm service areas, focusing on agri-business and closely held businesses and their owners. Holbrook & Manter is a professional services firm founded in 1919 and we are unique in that we offer the resources of a large firm without compromising the focused and responsive personal attention that each client deserves. You can reach Brian through www.HolbrookManter.com or at BRavencraft@HolbrookManter.com.