Wow, what a crazy year 2021 has been. Great yields, great prices, and high land value mean that now is a great opportunity to buy land—lots of public auctions, along with many private sales throughout this fall especially. One thing a grower can really utilize in any land purchase is a recent grid sampling service, as our expert team at E4 can deduct residual soil fertility from a farmer’s taxes.
This is an extremely beneficial advantage that growers can have when working with our team of expert agronomists, notably for the years of records, as we have sampled and prescribed fertilizer on many farms throughout the years. Having a high-quality soil test and fertility program with good fertilizer records can pay back some big dividends, not only yields but even with Uncle Sam.
What Can Be Claimed On Taxes?
Once farmland has been purchased, growers can claim depreciation on assets from that particular farmland that is considered depreciable (i.e., fencing, drainage tile, grain storage structures, farm-related buildings, etc.). This starts within the very first tax year in which the owner took possession of the land. The amount of depreciation claimed on the farmland is tied to the portion of the total cost of the property that can be set aside to any depreciable asset.
There are parts of the Midwest where above-average soil fertility is also eligible for expense deductions. The idea is called “residual soil fertility.” This concept leads to the deductions associated with residual soil fertility; that’s the topic the E4 team is going to focus on here.
How Is Residual Soil Fertility Determined?
There are legal statutes (written laws) on the Federal level that outline the framework of what can be deducted in what is known as the Internal Revenue Code (IRC). We’re interested in statute IRC §180, expenditures by a farmer for fertilizer, etc. This code explains that a taxpayer engaged in the business of farming can annually choose to treat expenses such as the cost of fertilizer, lime, potash, or other materials that enrich, neutralize or condition land used in farming as expenses, which are not chargeable to capital account expenditures during the taxable year.
If these fertilization costs are not expensed, they are required to be capitalized with expense deductions being amortized (gradually written off) over a presumed useful life–similar to field drainage tile or fencing.
This means that residual soil fertility is a capital asset (i.e., a significant piece of property) in the hands of an operating farmer, crop-share landlord, or cash rent landlord when farmland is obtained, with the cost amortized over the useful life of the asset. On average, that useful life typically spans three to four years. In this situation, the general 15-year amortization rules do not apply.
The IRS holds the position that fertilizer costs should be amortized based on the percentage of use or benefit each year. With that in mind, we can then determine that straight-line amortization most likely doesn’t apply. Our expert team of agronomists here at E4 can help establish proper information and data so that the property’s annual expense allocation can be determined (e.g., IRS Pub. 225, Chapter 4 of the Farmer’s Tax Guide).
In instances where farmland is inherited from a decedent, the date of the decedent’s passing is the starting date for determining whether residual soil fertility exists. If experts or a farmer can prove it, the cost can be amortized by the decedent’s estate or the beneficiaries of the estate that receive the farmland.
The determination of soil fertility was outlined in the mid-1990s when the IRS published a Market Segment Specialization Program (MSSP) addressing residual soil fertility. IRS MSSP, Guideline on Grain Farmers (Training 3149-133, Jul. 1995). In the document, it notes that IRS will deny a deduction for residual fertilizer supply unless the taxpayer can establish:
- Beneficial ownership of the residual fertilizer supply.
- The presence and extent of the residual fertilizer.
- That the residual fertilizer supply is actually being exhausted.
Expanding on that, the MSSP explains what IRS examining agents need to do to ensure that the values assigned to depreciable farm assets are reasonable (see also, Tech. Adv. Memo. 9211007, Dec. 3, 1991).
What Are the Proper Procedures For Deduction?
Just how can a grower go about establishing the presence and extent of residual fertilizer supply and that it is actually being exhausted? One method is if farmland has an actual excess soil fertility base, it will normally bring a price premium upon sale. This approach also applies for instances when farmland has well-kept fences, field drainage tile, and grain storage facilities–a price premium applies to factor in the existence of those assets. As for residual fertilizer supply, the excess amount can be measured by grid soil sampling. This is a service we offer at E4.
Our soil sampling methodology and trusted lab partners help growers determine the average (base) soil fertility for various soil types. Once the soil samples are gathered, the fertility levels of those samples are compared to the base fertility guideline levels for particular soil types to establish the amount of “excess” fertility on a tract of the desired farmland.
The goal here is to obtain data for the established base soil fertility for the type of soil on the purchased farmland from comparable tracts and comparable soil types. By establishing the base soil fertility, the actual sampling on the purchased property will indicate whether excess residual fertilizer is present on the farmland. It’s important to note that soil sampling should take place on or before the buyer takes possession of the farmland. For farmland that is inherited, the sampling should happen before the buyer applies any new fertilization.
Is Documentation Needed?
Even though the IRS does not explicitly say that documentation is required, it is best practice to document the deception for excess soil fertility in the off chance there is an IRS or state audit. One of the best approaches to documenting this is to have records about the allocation of value to the amount of above-average soil fertility in the purchase contract for the farmland. Another piece of documentation is an agronomist’s written overview of how the landowner calculated the fertility amount and the amount of time over which soil fertility would decrease due to crop production or other factors. This information helps frame the correct amortization period for excess soil fertility. Due to the countless soil types, deductions could range from $50 per acre to over $3,000 per acre.
What Does This Mean Overall?
Basically, when a grower gains new farmland, a certain allocation of that value can be made to depreciable item. In some parts of the United States, a depreciable item might be residual fertilizer supply. A grower can demonstrate this with proper information and data; tax benefits would be available. A grower should always follow IRS guidelines. However, abiding by IRS guidance on deducting excess soil fertility might not always work in some states. That’s why growers should consult with agronomists, like our E4 team, to determine what options are available. If you want to know more information about this particular topic or other aspects of farm management, give us a call at 712.647.2666!