Tax Treatment of Preproductive Expenses for Pecan Growers

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Tax Treatment of Pre-productive Expenses for
Pecan Growers

• Bill Bunn

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07 What to do - Varieties, Density,
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08 What to do awe rats, taxes
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Want to talk taxes
Marketable quantity under I.R.C. Treas.
Reg/1.2763A-4(b)(2)(ii) means more than a de
minimus crop yield, etc. etc.etc, Blah Blah
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PECAN GROWERS IN N.C.

• Few N. C. level growers are impacted
• Tax laws apply to one and all
• Commercial level growers several acres might
  benefit to know about
• Action in orchard could impact other farming
  activities

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Farmer or Not (1)

• No one single criteria determines, the code lists
  a number of factors to consider when making that
  determination.
• See Publication 225, Farmers Tax Guide
• If fail to qualify, activity is reported on
  taxpayers form 1040.

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Farmer or Not (2)

• Some Criteria are
• Depend of farming income for livelihood
• Knowledge to carry on farm operation
• Operate farm in business like manner
• Losses are due to uncontrollable factors
• Have been successful farmers in past
• Expect to make a profit

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Presumption of Profit

• Generally, the IRS applies the rule that a profit
  must be made three out of five years, to be
  considered a farm operation.
• Unavoidable conditions, eg. Hurricanes, droughts,
  etc are factors the IRS considers when applying
  the Presumption of Profit rule
• Documentation attached to Schedule F helps to
  explain unusual conditions

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Preproductive Period

• Internal Revenue Code recognizes Pecans as having
  a preproductive period in excess of 2 years,
  causing special tax treatment

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Defining the Pre-prod. Period of an OGV page 243
- 248

• General Rules
• The period ends when the marketable quantity pays
  for all direct harvest expenses plus some of the
  fixed and variable expenses or production for
  the year.
• Huge growers would reach this level at about year
  5-7.

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Taxpayers Choice

• Capitalize all preproductive cost, then
  depreciate that cost over 10 years. (Codified as
  Sect 263 a)
• OR
• Expense current operating cost, then depreciate
  establishment cost over 20 years. (tree cost not
  included)

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Establishment Cost

• The IRC code does not allow for expensing orchard
  establishment cost.
• Such cost include
• Cost of trees
• Land preparation
• Labor to plant trees

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Accounting Job 1

• Calculate the capitalized cost of orchard
  installation, if sold, costs are recaptured
• Cost of trees, installation labor, any other
  costs of the installation process
• The recapture is as ordinary income, not capital
  gain income

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Tax Consequences of Expensing versus Capitalizing
OGV Assets page 235 - 243

• Application to Orchards, Groves and Vineyards
  (OGV)
• Commercial Level Pecan Orchards must follow the
  UNICAP rules in IRC 263A
• Several Accounting Jobs need to be addressed by
  the orchard operator

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Accounting Job 2

• Total all the pre-productive costs
• Costs of trees and installation
• Costs of all husbanding until the pre-productive
  periods ends
• Include depreciation costs

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Accounting Job 3

• Allocate a portion of interest expense to the
  pecan trees over the pre-productive time frame
• 7 10 years of pre-production

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Accounting Job 4

• Electing out of the Uniform Capitalization Rules
  (Uni-Cap) then
• Need the costs from Accounting Job 1 to be held
• Need to use MACRS ADS lives for all depreciable
  assets for planting year
• Pecan orchard to be depreciated over 20 years
• OFTEN Election is made unknowingly!!!

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Accounting Job 5

• If the pecan orchard is a significant share of
  the total farming activities an analysis of
  equipment purchases should be done.
• Using the IRC 179 Expensing Election can take
  the sting out of the slower depreciation
• 128,000 for 2008.

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Most elect out of Uni-Cap rules

• Should capitalize the initial cost of trees and
  installation
• Remember to use the ADS lives of equipment
• The IRC. Sec. 179 expensing election can still be
  used
• 128,000 for 2008 (Proposed legislation increases
  this to 250,000)

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Casualty Losses
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Hurricane Losses (if any)

• For a business casualty loss, the loss is limited
  to the lesser of basis or the decrease in fair
  market value of the damaged property.
• Basis will be the capitalized costs of the
  pre-productive period if in compliance with
  UNICAP rules.
• If elected out of UNICAP rules, basis will be
  very small as the tax benefit from deductions was
  received in the past.

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Hurricane Losses (if any)

• Generally, then, the basis (cost) will be small
  as many pecan orchardists elect out of the UNICAP
  rules.
• There will be very little tax casualty loss to
  recover regardless of the economic damage.
• NAP Insurance through county FSA office, if
  qualified, is surest bet.

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The End