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Minimal Depreciation


Edsel

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One of my clients inherited thousands of acres of land.  He has (in round numbers) $100,000 annually in Farm Revenue.  But he has been buying $200,000 in equipment every year for the last several years.  He is peculiarly enamored by equipment, but cannot justify the money spent.  I have been trying to find ways to minimize his depreciation expense because he faces an NOL in many years.  For 2016, he spent $40,000 in 5-yr property, and $130,000 in 7-yr property.

The ADS tables stretches out 5-yr property to 6-yrs, and 7-yr property to 10 years.  I take half-year convention and only SL depreciation.

Any ideas on how to minimize depreciation any more than I already have?

It may have occurred to many readers how this guy continues to operate, as he faces an NOL in many years of up to $50K sometimes.  I grew up on a farm close by and being somewhat familiar, I believe he is reporting all his sales. But he continues to spend ridiculous amounts on top-of-the-line equipment that can never economically be justified.  He solves his cash flow problems by borrowing against his land.  At some point, his banker should just shut him down, as he owes some $2MM.  Land is worth probably $5MM, so there may be no end in sight for this continued idiocy.

 

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4 hours ago, jklcpa said:

Are you electing out of the bonus depreciation too?  Does the farm show a profit in enough years that profit motive won't be questioned, or is this a very expensive hobby?

I'm looking to reduce his depreciation, so "no" to bonus depreciation.  To be honest, I have not been using the election to bail out of the special depreciation and don't know anyone around here who goes to the trouble.  I'm aware that bonus depreciation is the default, but fill out the 4562, page 2, and ignore the statement. 

His farm never shows a profit, but there are some years when the combined Sch F and 4797 income nets out to a profit.  It's hard to paint a picture where this is a hobby, considering he doesn't have any other job.  It is virtually impossible to sell $100,000 worth of farm production a year and have time for anything else. 

I have several farmers who rarely show a profit, but virtually every single one of them has to pay horrific taxes when property is sold, as well as depreciation recapture on their equipment.  Most farmers are poor business managers, spending $$ on equipment that is rarely used because they don't wanna borrow from their neighbors.  They also spend big money on items such as fertilizer that cannot economically be supported.  Stupid doesn't mean they don't have a profit motive.

Land values around here escalate 5-10%, and the increase alone in any given year is usually more than a farm loss.  It is not unusual in this part of the country to find millionaires playing checkers on the public square with only one tooth in their head.

Thanks for your response...the threat of hobby loss for farmers is a good discussion.  I do have several "part-time" farmers where this is an issue.  Farming is so labor-intensive, any appreciable revenue requires more than casual time.

 

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7 hours ago, Edsel said:

I'm looking to reduce his depreciation, so "no" to bonus depreciation.  To be honest, I have not been using the election to bail out of the special depreciation and don't know anyone around here who goes to the trouble.  I'm aware that bonus depreciation is the default, but fill out the 4562, page 2, and ignore the statement. 

Yes, I realized you are trying to take the least amount possible. I wanted to get the facts on the election (or none) at the start of the discussion.

Technically, you and your client now have some problems if you failed to include the election to opt out of the bonus depreciation and you didn't deduct it either.  Now your client has phantom depreciation on those assets that he didn't get the benefit of either through current deduction or a larger NOL, and the regular depreciation you did deduct is also incorrect because it was calculated on a basis without reduction for the special allowance.  Without the election that bonus depreciation is still "allowed or allowable" even though you didn't report it. 

If I recall, you are using Drake, and the election is made on an original return and easily generated by the software by checking one box on screen 10. Without that election, the software will calculate the bonus depreciation automatically.  The program will allow input to override that calculation by entering a -0- on the bonus depreciation line. 

If the 2016 return hasn't been filed yet and your client doesn't want the special allowance, it's not too late to include the election. 

 

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5 hours ago, jklcpa said:

Technically, you and your client now have some problems if you failed to include the election to opt out of the bonus depreciation and you didn't deduct it either.

Judy, bluntly stated, I have not been opting out, nor have I been deducting it.  And I have no intention of recapturing the "excess" in the event of disposition.  If they catch me, then so be it.

I remember a seminar when they taught that "bonus" depreciation would be the new default.  Neither the instructor nor the class could believe the IRS would create such an extra hoop to jump through and failed to see the mentality behind it.  Since then, "bonus" depreciation has been on the chopping block and has been saved at least once by a now-annual December congressional reprieve.  This "bonus" depreciation is not allowed for many state tax returns so we can't depend on the "flow" to states via software.

I use a different program (other than Drake) to handle fixed assets and depreciation.

Like s.179, bonus depreciation in the early years of a business is rarely advantageous to the taxpayer.  It is better if they save some depreciation for later years where it will be much more needed than Year 1, instead of "going for broke" in the first year.

In spite of my disdain for the need for such an election, I am well-advised to listen to your advice.  If the requirement does not die a merciful death, I should be making this election in the future.  Thank you for the discussion.

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Why do you want to minimize depreciation, what is wrong with NOL's.  If eventually he sells or has income the nol will go against his income at income tax rates.  He will recapture the depr at capital gain rates. He is ahead by the spread.   As many of you know, my practice has a lot or real estate professionals and many have negative income [which is probably why Trump doesn't want his returns released].  In fact, if not already done, when a client tells me he is selling a building or in contract I immediately have then get a cost seg study done.  Often I filed the 3115 claiming extra depreciation in the same year as sale.  The savings is basically 10% of the extra depreciation.

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49 minutes ago, michaelmars said:

Why do you want to minimize depreciation, what is wrong with NOL's.

Thank you for your response, but several thousand dollars worth of effect is lost relating to wasted std deductions and exemptions.  Depreciation recapture on equipment is at ordinary income rates, because he never sells or trades real estate.  His massive real estate is what provides collateral for loans and the loans are what enable him to spend the ridiculous prices for equipment, so there is no chance he will ever sell real estate (which is land only and wouldn't have recapture anyway).

Buying into your idea, NOL's are often preferable in cases where you are confident the succeeding year is going to be very profitable.  NOL's can often reduce income off the top in years of high tax brackets in such a case. 

However, this is not likely to happen with my client, given his track record.  I believe you are comparing my client's operation to some of your own people who are involved in real estate, and the two do not really compare. 

I fear what happens to his survivors if he passes owing all that money against his assets.  You can't always save people from their own folly.

I'm going to ask again for ideas to minimize depreciation.  There has been quite a bit of helpful discussion about why I should or shouldn't do one thing or another, but I haven't heard the first idea about how to minimize depreciation.  Often on such a forum, the original question is ignored.

 

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45 minutes ago, michaelmars said:

Why do you want to minimize depreciation...

If this were my thread, my answer would be:  Because hobby.

I hate these "businesses" that lose money year after year after year and I fired two this summer.  I know, I know.  IRS is not going to get them.  I don't care.  My farm business makes money.  Sure enough.  If you're a grown @$$ man losing money on a farm business, you're lying.  Either it ain't a business or you ain't losing money.  I told one that his farm was a swimming pool.  You're trying to write off your swimming pool.

Sorry, Edsel, I too am off on a rabbit trail.  I don't see any way to minimize depreciation unless you say 50% of the use is personal or something.  Have him drive it to church or Wal-Mart.  All I can come up with.

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While the tax return is showing a loss due to depreciation, it would be obvious that he's not actually incurring a loss - right?

Many real estate investors will go a decade without showing a profit on their tax return. $5 million in assets and he's recognizing $100k in revenue is the problem (I'm assuming you were just using a low example).

 

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15 hours ago, RitaB said:

 If you're a grown @$$ man losing money on a farm business, you're lying. 

You've put me on the carpet, so I am compelled to respond.  For Rita, and the chorus of people who "like" what she says...he is not lying. 

Nobody is rude enough to call me a liar, but after lo these many years, no one seems to give me credit for knowing liars when I encounter them.  I have some that I am suspicious are giving calves to their kids to sell in their own names, and various other situations where I believe people are tip-toeing around the truth.  When the situation becomes such that I can no longer ignore common sense, I will quit them.  It is written of the devil that his most powerful trait is his ability to deceive, so I imagine some few of them may be able to fool me.

Remember that people can survive on losses if the losses are "on paper".  Especially if there is an endless supply of collateral creating cash coming from loans.  I comply with his request to furnish banks with copies of his tax return every year, and sure enough, when I prepare his taxes there are new loans.  To put this in perspective, you might google up the value of 2500 acres in Williamson County, Tennessee and get a handle on just how much collateral is available.

Below is what his farm income would be without the depreciation deduction.  Remember, depreciation on his equipment costs him nothing except debt service, since it is bought with borrowed money.

Year     Schedule F(prior to depreciation)     4797 income

2016            32,135                                                 23,427

2015            33,967                                                 68,427

2014            63,185                                                           0

2013              6,340                                                 10,283

He also has a trucking operation where he hauls his own grain to market, and grain for other farmers, clearing around $50K per year.  He can live somewhat comfortably on this income, as he does not have cash outflow for huge equipment expenditures.

Stupid?  Yes. 

A liar?  No.  This guy is 56 years old, and I've known him since he was a boy.  He grew up two miles from where I did.

Thanks to all who have responded in an attempt to advise how to reduce depreciation expense.  But he won't be driving a manure spreader to WalMart.

 

 

 

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Edsel, my point was that if you lose money on a venture year after year after year, you may have a hobby, not a business.  My guy whose farm I compared to a swimming pool was not lying about the numbers, he was lying about the definition of the activity.  Lying was apparently too strong a word.  My guy was mistaken because it goes on all the time and it lowers your tax liability so it must be good.  You know - writing off the costs of keeping up and enjoying your property against your salary at the job in town.  

Also, the bad joke about driving tractors to WalMart was meant in fun and to suggest that your farmer may have some of this equipment more for personal enjoyment and convenience than for a true business purpose.   That maybe you could minimize depreciation by assigning some of the costs to personal use and not depreciating some percentage at all.  If the equipment he's buying is not reasonable and customary for the activity, he may be buying it because he wants it, which is fine, but it might be more of a personal expense than a business cost. 

I do apologize, my friend, I was excited about wrapping up a like-kind exchange for my own sister's tractor trade, and my comments came across in a way I did not intend.  I never in a million years wanted to offend and I thought I was picking up the tone of your original post where you said his behavior was ridiculous, that he could not justify the expense, and there might be no end in sight.   I'm sorry, I totally missed it.

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No problem - not intending to ask for an apology.  We know each other well enough to not worry about that.  It just seemed like a whole gallery of board members were tag-teaming with you to buy into the idea of a lying farmer when they didn't know the client or the situation.

There is a worthy discussion about hobby income and why it should be avoided.  You are forced to claim all the revenue on line 21 and are only allowed deductions on Sch A with a 2% throwaway.  Imagine what $100,000 in farm revenue would do on line 21, and expenses limited on Sch A.  To be honest, I would rather not even know about hobbies than to go through this phony collection activity on behalf of the IRS.  But you can't ignore reporting $100K in revenue, especially when there are $15K in 1099s for machine hire.

I congratulate you if you have your own farm operation and report a profit.  Maybe 1/3 of my farmers report a profit, the rest of them are poor businessmen making uneconomic purchases, and even still have to pay a ton of tax money when they sell their property.  One of the factors used by the IRS to determine hobby is how much time is spent on the activity - and if you have a farm yourself you can only imagine how much time is require to raise and sell $100,000 in a single year.

For what it's worth, I am much more aggressive in disallowing Sch C losses than I am Sch F.  And I won't put up with a farmer who spends $5000 in feed and $3000 in fertilizer, and never seems to sell more than 2-3 calves.  Some of our job is knowledge of tax laws, and some of it is just plain common sense.

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I don't have any big-time farmers as clients, so I don't run into this type of situation.  However, I agree that the lenders' practices are at the least highly suspicious.  I can't recall how many times I've had to explain to clients why a bank turned them down because the bank lends money based on "ability to repay" rather than the size of the collateral.  The client wants to borrow against the value of their assets, but the bank wants to see an income level sufficient to service the debt.  Collateral is necessary, but it's usually the bank's fall-back position. Most banks hate to go after collateral when loan defaults.

If what you describe is the norm, then it seems that banks dealing with farmers take a much different approach. The only way this guy can be continually buying new equipment is to roll over ballooning debt.  One could jump to the conclusion that an underlying goal is to get possession of the land in the long run.

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We click on the "like" for a variety of reasons so you shouldn't use those as affirmation or agreement with the technical aspect of the post.  Likewise, a perfect answer that is correct in all aspects may garner zero likes at all.  If someone is wrong, we aren't shy about pointing out the error and continuing the discussion.  You'd have to know the personalities of the posters and those using that function. Many of our members stop visiting or posting off-season, and since you joined on April 16th of this year you may not know everyone well enough to judge the tone yet.

I wouldn't consider 2 likes and 2 laughs a whole gallery of members considering the number of posts, posters, and views this topic has already had.  I can only speak for myself, but my "like" was the mention of Rita telling off her client wanting to deduct a swimming pool and the visual of someone driving industrial farm equipment to Walmart, plus we love Rita and her way of breaking the tension with her humor. 

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I just went through an audit and the agent actually told me that it was selected because of 3 years of losses.  This client went into the business of selling high end homes 3 million and up on average.  2013-no income just expenses, 2014-small income since she was apprenticing and only got a small percentage of commission.  Expenses exceeded income. 2015 was more income but still showed a net loss.  What saved us from having to argue the hobby rule with the agent is, a] she understood the business and knows the local market and b] 2016 had nice commissions and 2017 had a few large ones too. 

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Part of our reaction to your client's situation might have been because we didn't have all of the facts of this client's revenue stream, your mention of the NOLs, that he doesn't have any other job, and that it's hard to have time for anything else with his level of production and gross farm revenue. We now know that in addition to the farm operation and equipment sold, he has income from a separate trucking operation and machine rentals.

JohnH made good points about the bank allowing the continued borrowing, and the ballooning debt you described is a problem.  I've seen banks that use a client like this, one that looks great on paper with nice collateral and excellent credit, to prop up and offset other less-than-stellar loans in their portfolio.

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2 minutes ago, JohnH said:

I agree with Judy.  2 likes and 2 laughs is more akin to an electoral vote rather than a popular vote. :)

Don't anybody dare respond to this post, as it will be deleted if Judy deems it necessary. 

You agreed with me but didn't like my post!  I'm devastated.   :P

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50 minutes ago, RitaB said:

I don’t know why driving a tractor to Walmart is funny to you people. My sister would do it in a heartbeat. And my sister in law drove one to the store to get cigarettes when she was 14. :)

This happened here over the summer. Some stoned guy without a shirt, stole a tractor and drove it to town. He was asking people for sandwiches in the Walmart parking lot. 

Report: Shirtless tractor driver yells for sandwiches

Man's driver's license had been suspended

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I had one other worrisome thought that goes back to the missed election to opt out of the bonus depreciation. The election was missed yet that extra amount wasn't deducted, so the effect is that expenses and NOL were minimized, and there is no statement with the return that puts the bank on notice of that.  We all know that banks think accountants have deep pockets and will try to lay blame on us when the loans go bad, and with the bank relying on these tax returns as part of the basis for their lending decisions, I think you may have some exposure here.

This is not an insignificant amount of debt, so I'd suggest that you have documentation in your files that you and your client discussed the effect of making the election, that he made an informed decision on opting out, and make sure that the election is attached to the returns in future.

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