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Understanding Depreciation and Accounting Methods in Farming

Learn about cash vs. accrual accounting, advantages and disadvantages of each, farm income and expenses, depreciation, IRS conventions, and depreciation schedule examples for different farm assets.

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Understanding Depreciation and Accounting Methods in Farming

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  1. Taxes Chapter #9

  2. Which Accounting System Is Best For You? • Cash or Accrual? • It depends on your individual situation

  3. What is the Cash Method of Accounting? • Records income and expenses in the period in which they are actually received or paid • Inventory is not used • Taxes paid on income minus expenses

  4. Advantages: Easier no inventory Flexible Timing can plan income and expenses Disadvantages: Inaccurate measure of profitability ex: cash transactions on first or last day of year Income Variations sell current crop & last years at same time Advantages & Disadvantages of Cash Accounting?

  5. Accrual Method • Records income when it is earned and expenses when they occur • Uses an inventory • An increase in year end inventory is treated as income

  6. Advantages: Accurate measure of profitability Reduces variation in income Disadvantages: More bookkeeping Can create tax liability on items not sold yet Advantages & Disadvantages of Accrual Accounting

  7. Farm Income • Sale of raised products • Sale of items purchased for resale • Government Program Payments • Patronage Refunds • Crop Insurance proceeds • Custom Hire

  8. Farm Expenses • Feed, seed, fertilizer, fuel, labor • Depreciation, rents, interest • Repairs, taxes, utilities, storage

  9. What is Depreciation? • Assets with a useful life of more than one year, may not be deducted as an expense in the year of purchase • Part of the cost of the asset will be deducted in each year of that asset’s productive life until the value is zero

  10. What can be depreciated? • Useful life of more than one year • Used in the business • Must be purchased

  11. What information is needed to calculate depreciation? • Basis: cash paid plus depreciable balance of their trade-in • When placed in service • Which method of depreciation to use

  12. Methods of Depreciation • General Depreciation System (GDS) • Modified Accelerated Cost Recovery System (MACRS) • recovers cost quicker • GDS & MACRS can use Straight Line or Declining Balance options

  13. MACRS • 3 Year Property • Breeding Swine • 5 Year Property • Breeding Sheep, Cattle • Trucks, Computers • 7 Year Property • Machinery, Equipment, Fence • 10 Year Property • Single purpose lvstk/hort struct.

  14. MACRS • 20 Year Property • Farm Buildings • 27.5 Year Property • Residential Property • 31.5 Year Property • Office buildings, motels, stores

  15. Straight Line Depreciation • Purchase price of asset divided by the years of service • Ex: $140,000 combine depreciated over 7 years = $20,000 per year

  16. Declining Balance Method • Gives largest depreciation deductions at the beginning, then smaller each year • More accurately represents the wear and tear of the asset

  17. Section 179 Expense Deduction • Allows you to take up to $17,500 of the purchase price of an asset the first year, then depreciate the rest • Ex: $140,000 combine, Sec. 179 of $17,500 first year = new basis of $122,500 • Depreciate $122,500 over 7 years = $17,500 per year • Why use Section 179?

  18. Convention • The IRS does NOT allow you to take a full year’s depreciation for the first year that an asset is placed in service • May use the month, quarter, or year the asset is placed into service • Mid-Month, Mid-Quarter, Mid-Year

  19. Convention • Mid-month convention etc. only affects the first and last year of a depreciation schedule • Ex: If you purchase a $140,000 combine in August • Depreciated over 7 years = $20,000 per year • Year #1 dep. = 5/12 $20,000 • Year #2-7 dep. = $20,000 • Year #8 dep. = 7/12 of $20,000

  20. Develop a Depreciation Schedule for the following: • Item purchased: Tractor • Date purchased: May 5 • Cost: $70,000 • Years of Service: • Straight Line Depreciation • Convention: Mid-Month

  21. Answer • Year 1 = $6,667 • Year 2 = $10,000 • Year 3 = $10,000 • Year 4 = $10,000 • Year 5 = $10,000 • Year 6 = $10,000 • Year 7 = $10,000 • Year 8 = $3,333

  22. Develop a Depreciation Schedule for the following: • Item purchased: Tractor • Date purchased: Dec 5 • Cost: $70,000 • Years of Service: • Straight Line Depreciation • Section 179 Deduction: $17,000 • Convention: Mid-Quarter

  23. Answer • Year 1 = $ 1,893 • Year 2 = $ 7,571 • Year 3 = $ 7,571 • Year 4 = $ 7,571 • Year 5 = $ 7,571 • Year 6 = $ 7,571 • Year 7 = $ 7,571 • Year 8 =$ 5,678

  24. Develop a Depreciation Schedule for the following: • Item purchased: 10 Heifers • Date purchased: Sept. 10 • Cost: $800 • Years of Service: • Straight Line Depreciation • Convention: Mid-Month

  25. Answer • Year 1 = $ 400 • Year 2 = $ 1,600 • Year 3 = $ 1,600 • Year 4 = $ 1,600 • Year 5 = $ 800

  26. Develop a Depreciation Schedule for the following: • Item purchased: Pickup • Date purchased: Feb. 27 • Cost: $24,000 • Years of Service: • Straight Line Depreciation • Convention: Mid-Month • Business Use: 75%

  27. Answer • Year 1 = $ 3,300 • Year 2 = $ 3,600 • Year 3 = $ 3,600 • Year 4 = $ 3,600 • Year 5 = $ 300

  28. Develop a Depreciation Schedule for the following: • Item purchased: Barn • Date purchased: Sept. 23 • Cost: $20,000 • Years of Service: • Straight Line Depreciation • Convention: Mid-Year

  29. Answer • Year 1 = $ 500 • Year 2-20 = $ 1,000 • Year 21 = $ 500

  30. Develop a Depreciation Schedule for the following: • Item purchased: Computer • Date purchased: October 22 • Cost: $3,000 • Years of Service: • Straight Line Depreciation • Convention: Mid-Month

  31. Answer • Year 1 = $ 150 • Year 2 = $ 600 • Year 3 = $ 600 • Year 4 = $ 600 • Year 5 = $ 600 • Year 6 = $ 600

  32. Develop a Depreciation Schedule for the following: • Item purchased: Bull • Date purchased: May 3 • Cost: $2,000 • Years of Service: • Straight Line Depreciation • Convention: Mid-Month • Section 179 Deduction: $2,000

  33. Answer • Year 1 = $ 267 • Year 2 = $ 400 • Year 3 = $ 400 • Year 4 = $ 400 • Year 5 = $ 400 • Year 6 = $ 133

  34. Develop a Depreciation Schedule for the following: • Item purchased: Fence • Date purchased: July 30 • Cost: $6,000 • Years of Service: • Straight Line Depreciation • Convention: Mid-Month

  35. Answer • Year 1 = $ 428 • Year 2-7 = $ 857 • Year 8 = $ 429

  36. Develop a Depreciation Schedule for the following: • Item purchased: Car • Date purchased: March 19 • Cost: $15,000 • Years of Service: • Straight Line Depreciation • Convention: Mid-Month • Business Use: 25%

  37. Answer • Year 1 = $ 625 • Year 2 = $ 750 • Year 3 = $ 750 • Year 4 = $ 750 • Year 5 = $ 750 • Year 6 = $ 125

  38. Strategies to Increase Taxable Income • Sell marketable grain/lvstk • Off Farm Income • Postpone expenditures until beginning of next year • Pay bills begin. Of next year • Don’t use Section 179

  39. Strategies to Reduce Taxable Income • Postpone sales until next year • Use deferred sales contracts • Buy machinery, supplies etc before end of year • Use Section 179 • Make advanced purchases

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