Stupid or Not??

[Beersheba]

I would never have done this - but maybe my customer is smarter than me....

Farmer/HeavyEquip operator inherited 3000 acres from his father in 2003. In Middle TN this is worth some $50 Million and has increased prodigiously since 2003.

Since then he has reported some $200,000 revenue from farming, hay sales, and custom (machine hire). I have no reason to believe he is not turning in all his revenue. However, he has shown a loss every year. Here's why.

1. It is difficult for a farm operation to make a profit to begin with, unless you are in timber or farm belt.
2. He has purchased $150,000 of equipment (or more) every year, putting up his land for loan collateral. Has never had to rely on s.179.

Of course, his depreciation expense is huge, as well as his interest expense. He reports a loss every year, and tells me his tax strategy is to always buy enough equipment to create losses through depreciation. Taking everything in consideration, I report a loss, because his strategy, smart or otherwise, makes the numbers such that losses are reported..

The result of this strategy is he has some $3MM in equipment (original value) and even more than this in associated Liabilities.

Forward to 2022, and a developer has offered him $5,000,000 for some of his land. There are loans for appx $800,000, which will have to be paid off and of course will be non-deductible. His basis in the sale is roughly $2,000,000. Yes, $3,000,000 in LTCG.

He will have about $50K in NOL to apply against his 2022 tax return.

In order to reduce his tax liability for 2022, he plans to buy 3 land excavators @ $200,000 apiece, and take s.179 for $600,000.

Thank you for reading this tedious message so far. Here is my question:

I believe s.179 can only be applied to an operation (farm or business), and only to the extent of profit. His farm/equip operation will be marginally profitable if at all. He has heard that he can buy $600,000 of equipment and apply it to capital gains. I've told him no.

Is he correct???

[Uncle Sam]

The client buys new equipment EVERY YEAR? And on top of that produces tax losses every year?
Are the losses before or after the Sec 179 deduction?
He must have some inventory of equipment. I wonder what his farm's depreciation schedule looks like. Does he ever sell off, trade-in, or scrap the older equipment and payoff the debt used to acquire them?
He also must have a pretty big insurance premium to keep all those fixed assets.

Can't answer your last question - you didn't state whether his business is a Schedule F or a corporation entity or S Corp.

[TaxGuyBill]

Regulation 1.179-2(c): Items of income that are derived from the active conduct of a trade or business include section 1231 gains (or losses) from the trade or business

https://www.law.cornell.edu/cfr/text/26/1.179-2#c

[Beersheba]

The client buys new equipment EVERY YEAR? Yes, and not unusual to spend $200k per year. And on top of that produces tax losses every year? Yes, his original value of equipment approaches $3MM, and annual depreciation between $120K and $180K and this is without s.179.
Are the losses before or after the Sec 179 deduction?
He must have some inventory of equipment. I wonder what his farm's depreciation schedule looks like. Does he ever sell off, trade-in, or scrap the older equipment and payoff the debt used to acquire them?
He also must have a pretty big insurance premium to keep all those fixed assets. Yes he does. Outrageous,and all of it deductible.

Can't answer your last question - you didn't state whether his business is a Schedule F or a corporation entity or S Corp.

He files a Sch F and a Sch C every year. His F is always a large loss, and his C is marginally profitable some years.

[Beersheba]

Regulation


https://www.law.cornell.edu/cfr/text/26/1.179-2#c

Thanks for the link TaxGuyBill. From the language in the link, it appears the income limitation is restricted to a trade or business. However, does not state whether the "trade or business" includes LTCG arising from the trade or business. Can you reflect further?

[TaxGuyBill]

I am pretty sure it means that if it was a business asset, then the gain/loss of that business asset is added to the business income for purposes of Section 179. So he has an extra $3,000,000-ish of income that CAN be used for Section 179 purposes.

[Rapid Robert]

"his tax strategy is to always buy enough equipment to create losses through depreciation. Taking everything in consideration, I report a loss, because his strategy, smart or otherwise, makes the numbers such that losses are reported.."

How is that an ordinary and necessary business expense?

"The client buys new equipment EVERY YEAR? And on top of that produces tax losses every year?"

Yeah, sounds like he doesn't know much about the business of farming.

[Lion]

Is it a hobby or a business? Is he even trying to make a profit?!

[Beersheba]

Is it a hobby or a business? Is he even trying to make a profit?!

I understand why such a question would be asked.

Definitely not a hobby. I grew up on a farm and I know how much effort is required to drag in $150,000 annually. No way this is a hobby.

The other question (trying to make a profit) is perhaps more applicable. He is intentionally buying more equipment (with a heavy loan factor) to erase any potential profit.

The profit motive for farming has elements not present in other industries. For most cattle and row crop farms in TN, the costs usually exceed revenue. However, the value of the land escalates faster than the operational losses. But until land is sold, the profits are not reportable. Similar to stocks which have exploded in value but not taxable because they are never sold.

Also, if you own a farm, you MUST operate it or rent it. If you just let it sit, the weeds and saplings will take over and severely devalue the property. There are exceptions, such as 100% in timber where no pasture exists to grow, and years where timber is sold will report a substantial profit.

Living where I do, I prepare several farm Sch F returns, almost all of them show a loss, but when the land is sold, the LTCG on a 4797 usually overwhelm the accumulated losses, such is the case with my subject customer described in this thread.

[Uncle Sam]

So the thinking of this client is, knowing that the sale of the farm land is someday going to produce a humongous profit, he's going to load up with excess Section 179 depreciation deductions now, let them accumulate, until he sells the land, THEN apply the excess 179 deductions?
Why can't he save himself the trouble of losing time value of money, and simply lease the equipment where he can take a current deduction for the lease expense without having to go into debt?

[kathyc2]

Even using a ridiculous high value of 50K per acre that would mean at least 1000 acres. At 200K of gross receipts, that works out to $200 per acre. If someone came to me with this info, I'd be asking a LOT of questions.

Reread the OP and saw it is 3,000 acres. That works out to $67 per acre in revenue. Sounds to me like he's growing fudge.

[Beersheba]

Thanks to all who have contributed.

And yes, Kathy, I do ask a lot of questions, and I don't audit if they seem reasonable to me. Not sure where you live, but farming in TN is not the same as that flat stretch of land stretching from Columbus OH to St Louis MO. Or North Dakota. There are steep hills, ravines, creeks, etc. The TN "Greenbelt" law (defining a farm for property tax purposes) is only $35/acre of production. Flat land around 40 miles from Nashville selling for $25K per acre. Land that is not flat at least $10K per acre.

And again, from the outset, I'm certainly not supporting the wisdom of this farmer. Personally, I am vehemently opposed to incurring debt.

[kathyc2]

For the most part farm income is based on the honor system as 1099's for income are rare. I wouldn't be putting my name and credibility on a return with these numbers, but to each their own.