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Concerning electing to capitalize costs & carrying charges


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Capitalization of Expenses?  I do this for a few people - farmers in particular.

Attention is drawn to the discussion about which expenses can be capitalized.  From the discussion, only interest and taxes, and there is no interest.  And taxes in 2018 are limited to $10,000.

I approach the farmers as though the only expenses which can be capitalized are those expenses which can be deducted.  Many farmers purchase vacant land and let it sit.  Anyone who knows about farming knows that it cannot just "sit".  It has to be mowed, fenced, and maintained, and these expenses are not as small as mowing your front lawn.

So I capitalize those expenses which can be deducted on a Sch F.  The acreage is available for use, and in most cases it ultimately is used for pasture in later years.  Is this questionable?  I still believe it is conservative because most farmers expect me to deduct it outright and claim a loss on the land.  I won't do that if it is just sitting there.

Moving the discussion to timber.  Standing timber can never be used for farming as long as the timber is there.  I capitalize interest and taxes for the timber until sold, and limit the capitalization to interest and taxes only.  In the year of a sale, I deduct expenses of the sale.  Typically in these parts, standing timber is left for years and years before sold, and is capital gain or loss.  There are operations who harvest timber every year and this is ordinary Sch F income - farmer/clients who do this are practically non-existent - operations such as this are run by huge companies like Boise-Cascade or Champion Paper.

 

Moderator note - the above post was moved out of the topic entitled "No BS" because that discussion is still ongoing for a specific case, and the above post may have derailed it into other areas of farming and timber.

Edited by jklcpa
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13 hours ago, Corduroy Frog said:

So I capitalize those expenses which can be deducted on a Sch F.  The acreage is available for use, and in most cases it ultimately is used for pasture in later years.  Is this questionable?  I still believe it is conservative because most farmers expect me to deduct it outright and claim a loss on the land.  I won't do that if it is just sitting there.

If those are Schedule F expenses allowable under section 163, then  why would you capitalize instead of taking the deduction to maximize the tax benefit to your client?  The 266 election is for allowable expenses, so they should be deducted if that is to the advantage of your client.

If this is an isolated  parcel which farmer is holding strictly as an investments, then the expenses would fall under section 212 otherwise deductible as misc on Sched A, subject to TCJA.

13 hours ago, Corduroy Frog said:

capitalization to interest and taxes only.  In the year of a sale, I deduct expenses of the sale

What reasonable method do you use to allocate those cost?  You would have to allocate by the amount of standing  board feet of timber at the end of each year,  then recognize per board foot as logged. 

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On 9/12/2020 at 12:42 PM, DANRVAN said:

If those are Schedule F expenses allowable under section 163, then  why would you capitalize instead of taking the deduction to maximize the tax benefit to your client?  The 266 election is for allowable expenses, so they should be deducted if that is to the advantage of your client.

If this is an isolated  parcel which farmer is holding strictly as an investments, then the expenses would fall under section 212 otherwise deductible as misc on Sched A, subject to TCJA.

What reasonable method do you use to allocate those cost?  You would have to allocate by the amount of standing  board feet of timber at the end of each year,  then recognize per board foot as logged. 

Thanks for responding DANRVAN.  I don't know whether this answers all your questions or not, but to some degree this is often a "facts and circumstances" situation.  It starts with the purchase of acreage, maybe 50 acres, and I'm told the intent is to put cattle on the acreage.  3-4 years later the pasture is still vacant and is being mowed.  I am still told cattle will be there.  I simply cannot deduct Sch F expenses in such a case.  I generally tell the owner that we will begin deducting expenses when the cattle are there.  I will deduct expenses with cattle even though there are no sales, because it takes several months for calving to be ready for market.

Answering your question about allocation of expenses to timber, I don't know any sophisticated means of measuring growth patterns and expected board feet. If there are 20 acres of timber and 80 acres of pasture, I will allocate 20% of the taxes and interest to the timber, using acreage as an allocation base.  If a farmhouse is there, there is an initial allocation of taxes based on tax appraisal, and this is true for interest if purchased all at once.  Otherwise interest is traced to the purpose of the loan, and there could be multiple loans.

Your home state has a multi-bilion $ timber industry, and the aforementioned sophisticated methods are more likely commonly used in Oregon.

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1 hour ago, Corduroy Frog said:

  I simply cannot deduct Sch F expenses in such a case.

Not knowing the facts and circumstances, I would inquire as to the business purpose  in order to justify the expense.  Are they holding as a reserve for drought years?  Future expansion?  An adjoining piece of property bought to avoid new neighbor conflicts ( encroachment of non-farmers) ?

In my area there is a high demand for pasture so capitalizing idle ground is not a concern.  Mowing unused pasture is unheard of and in most cases not practical due to the terrain and acres involved.

1 hour ago, Corduroy Frog said:

allocate 20% of the taxes and interest to the timber, using acreage as an allocation base

I don't believe that is an accurate allocation method.  The 20 acres in your example has two components; the land and the timber.  You would need to know the value of both to make a reasonable allocation,  that was the point of my question.  To go further with this, you would also need an estimate of the standing timber volume in order to track the expenses on a board foot basis.  Otherwise, how will you know how much to write off when x amount of timber is logged off and y amount is left standing?  Do you see a record keeping issue here?

For the ranchers with both pasture and timber,  grazing is the primary purpose and the timber is incidental.  I have never seen an accountant make an allocation in that situation; it is all wrote off.

1 hour ago, Corduroy Frog said:

Answering your question about allocation of expenses to timber, I don't know any sophisticated means of measuring growth patterns and expected board feet.

Getting off topic, but I have consulted with foresters to back track basis of timber sales using growth rates and historical sale prices.

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Thanks for your response, DANRVAN - this is quite typical of geographical differences.  In your state, you can holler down the street and 3-4 forestry experts will turn around and look at you.  Down here, you won't find one except at large sawmills, and when you're getting information for the tax return, the farmer/client doesn't even know one, and even if he did he wouldn't pay for the information.  The thing that keeps him from getting ripped off is his typical contract calls for 50% of the proceeds.

You are much more able to find a tree-trimmer to cut dangerous trees away from your house than a trained forester.  Many farmers can't even look at a tree and tell its species.

 

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