Farmers, ranchers and small-business operators can elect to take additional deductions in the first year for machinery and equipment purchases in 2011. These elections were extended under the recent tax law changes, according to Texas AgriLife Extension Service economists.

With rising commodity prices and some rain, many farmers and ranchers will likely see a boost in gross income for 2011. Some will be looking to replace aging machinery or purchase new equipment for their operations, the economists said.

“Before finalizing any purchase deals, however, be sure you understand the tax options available,” said Jose Pena, AgriLife Extension economist in Uvalde. “As always, it’s a good idea to consult with your tax advisor to see how this will impact your financial situation before making a decision.”

Dr. Gene Nelson, an economist specializing in financial management in the department of agricultural economics at Texas A&M University, said when depreciating equipment two types of deductions are available – the Section 179 expensing election and first-year bonus depreciation.

“These two options have different characteristics and apply to some different situations,” Nelson said. “But in some cases, the two elections can be combined. The bonus depreciation can be claimed after any Section 179 expense deduction and before figuring the regular depreciation.”

Nelson said when depreciating the costs of machinery, equipment or structures, farmers should be aware of these differences between the two options:

  • Section 179 expensing election: Businesses have the option of taking an immediate deduction of up to $500,000 of the cost of tangible property purchased in 2011 in lieu of depreciation. The purchased property may be new or used. But in the case of a trade-in (like-kind exchange) only the “boot” paid is eligible for expensing.
  • Bonus depreciation: Under the 2010 Tax Relief Act, first-year depreciation options are expanded by allowing businesses a depreciation deduction of up to 100 percent of the cost of qualified new (not used) property acquired and placed in service from Sept. 9, 2010 through Dec. 31, 2011.

Factors to consider

When comparing the Section 179 expensing option and bonus depreciation, Nelson said several factors should be considered when deciding whether or not to elect one of these options.

For example, the timing of the purchases will affect the amount of the tax benefit available. Property purchased in 2011 is eligible for 100 percent bonus depreciation, but for property purchased in 2012 it will be 50 percent.

“The maximum deduction for Section 179 expense is $500,000 in 2011 and $125,000 in 2012,” Nelson said.

The overall level of income expected for the year may also affect the option choice.

“The amount of the Section 179 deduction cannot exceed the taxable income from the taxpayer’s trades and businesses. Any excess deduction above the trade or business taxable income can be carried over and deducted in the next year subject to certain Section 179 limits.”

On the other hand, Nelson added, first-year bonus depreciation can be deducted in a low-income year creating a net operating loss, which can be carried back to previous tax years or carried forward.

The type of property you acquire also affects which option can be used. For example, a machinery shed or general purpose farm building (tangible property with a MACRS depreciable life of 20 years or less and that meets certain requirements) would be eligible for bonus depreciation, but not for Section 179 expensing.

Only property purchased new is eligible for the first-year bonus depreciation, while either new or used property is eligible for Section 179 expensing.

“Remember, these depreciation options do not increase the total amount of the deductions over time,” Nelson cautioned. “They simply accelerate the cost recovery, moving the deductions to an earlier year and leaving smaller deductions in later years.”

Therefore, he noted, they likely will be more advantageous in years when net income is expected to be higher than normal.

For a complete overview of the tax law changes, visit http://agecoext.tamu.edu/resources/library/federal-income-taxes-recent-references.html.