Can non-corporate lessors elect section 179 to expense assets in a farm operation?
Taxpayer Says: The farm-related property is section 179 property and is deductible under an exception to the non-corporate lessor limitation.
Internal Revenue Service Says: As non-corporate lessors, the taxpayers are barred from claiming a section 179 deduction for the amounts paid for the property.
From Internal Revenue Code Section 179(a): A taxpayer may elect to treat the cost of any section 179 property as an expense which is not chargeable to capital account. Any cost so treated shall be allowed as a deduction for the taxable year in which the section 179 property is placed in service.
From Internal Revenue Code Section 179(d)(5): While the entire cost of section 179 property may generally be deducted in the year of purchase, a taxpayer generally will not be permitted a section 179 deduction if the taxpayer is not a corporation and the taxpayer purchased the property for leasing purposes.
From Internal Revenue Code Section 179(d)(5)(B): Non-corporate lessors may expense the cost basis of section 179 property by meeting a two-prong test. First, the term of the lease, taking into account options to renew, must be less than 50% of the class life of the leased property. Second, section 162 business expenses for the leased property claimed during the initial 12-month period following the transfer of the property to the lessee must exceed 15% of the rental income produced by such property.
THE CAUSE OF THE DISPUTE
In general, section 179 of the Internal Revenue Code allows an immediate deduction of the cost of certain property that you buy and place in service in your business during a tax year. Some taxpayers have to meet special requirements to be eligible for Section 179 expensing
For example, when your business is not a corporation and you buy the property and lease it to someone else, one requirement for electing Section 179 is that the lease term has to be less than half the life of the asset. A second requirement is that the expenses related to the property during the first year have to be more than 15% of the income produced by the property. These “non-corporate lessor” rules were designed to limit leasing arrangements motivated solely by tax-saving purposes.
In this case, the taxpayers, who were farmers, bought grain bins, a grain dryer, drainage tile, a pickup truck and fencing. They leased this property to two corporations under oral agreements, and expensed the cost on their income tax return. Though they did not provide evidence as to the terms of the leases, the taxpayers believed they met the special requirements for non-corporate lessors because the leases were reviewed each year. They argue the annual review meant the lease term was a year long, making the term less than 50% of the class life of the property.
The IRS says there’s no evidence the lease terms were one-year renewable. Therefore, the terms of the leases are indefinite and do not satisfy the requirements, so the property is not eligible for Section 179 expensing.
WHAT WOULD YOU DECIDE?
Make your selection, then see “The Court’s Decision” below for a full explanation
THE COURT’S DECISION
HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.
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