Issue link: http://winesandvines.uberflip.com/i/152772
grapegrowing Deductibility of soil amendments BY L. Gregory Scott and David G. Pardes, PwC Private Company Services uccessful farming requires a substantial amount of cash to be invested in developing and caring for the land on an annual basis. These land-related expenditures may be required to be capitalized or expensed, depending on the situation. Therefore, it is pertinent for taxpayers to understand exactly how to account for these expenses on their tax returns. Internal Revenue Code (IRC) Sections 180 and 175 provide opportunities for taxpayers to expense costs that too often end up being capitalized on the balance sheet, which directly impacts annual after-tax cash flow. S not residual fertilizer that is part of the land value in a farm acquisition is depreciable. Substantial authority is extremely limited with respect to IRC Section 180. However, a private letter ruling (PLR) that was issued in 1991 (PLR 9211007) offers clarification on this issue. IRC Section 180: Soil amendments IRC Section 180 allows for the deduction of anything used to fertilize, amend, neutralize or enrich soil to be used in farming. This would include the cost of labor associated with application of the soil amendments. For growers who process grapes into wine and are required to use the accrual method, the cost of soil amendments is capitalized into grapes in progress, moves into wine inventory and would not be deducted until the wine is sold and the expense rolls out of inventory through cost of goods sold. For wineries that primarily make wines requiring a lengthy aging process, this could mean that soil amendment costs remain on the balance sheet for up to three years or more. An election to deduct IRC Section 180 costs is made by taking the deduction on the taxpayer 's tax return and is only effective for the tax year in which the deduction is claimed. As such, this deduction is not considered an accounting method. It is an election that must be made on an annual basis, which provides for flexibility since the taxpayer can analyze annually whether or not it makes sense to make such an election. Residual fertilizer One common question that has arisen as a result of this code section is whether or In PLR 9211007, a farm corporation bought buildings, irrigation and the residual fertilizer supply included in the land. The actual land was acquired separately by two shareholders of the farming corporation (as individuals apart from the corporation) and leased to the farm corporation. It was the practice of the seller of the land to apply a truckload of fertilizer annually, which contributed to a high level of fertilization in the land. The farm corporation claimed depreciation deductions over a seven-year period for the amount that was identified in the purchase as residual fertilizer supply. The PLR specifically states that a taxpayer "may amortize the cost of fertilizer applied to farmland over a specified period of time if the taxpayer in fact paid or incurred costs for the fertilizer and is exhausting it. However, the PLR goes on to say that "a taxpayer must be beneficial owner of the fertilizer in order to be permitted an amortization deduction." Since the taxpayer (the farming corporation) leased 58 p r acti c al w i ne ry & v i ne yard S EPTE MBER 20 13 the property from two individuals, the corporation was not deemed the beneficial owner of the fertilizer, and the depreciation deduction of the residual fertilizer was disallowed. While the depreciation deduction was disallowed in this PLR, it clearly specified the requirements that would need to be in place in order for the taxpayer to properly deduct residual fertilizer depreciation. In addition to the beneficial ownership requirement, a taxpayer must: 1) Establish the presence and extent of the fertilizer, 2) Demonstrate evidence indicating the period over which the residual fertilizer will be exhausted. In order to obtain this information, it would be necessary to hire a licensed soil scientist or agronomist that would be able to test the soil and document the findings. The documentation by the soil scientist would specifically state the extent of the fertilizer and the extent of time it would take to utilize the residual fertilizer. It would also be important to break out the value of the residual fertilizer from the land value in the agreedupon purchase price allocation exhibit of the purchase agreement in order to identify the depreciable tax-cost basis. While a PLR is authoritative, the IRS is not bound by the conclusions in a PLR. It is only binding between the IRS and the taxpayer that requests the ruling and does not establish a precedent. However, PLRs may be used as a guide to understanding the position that the IRS may take in the future on similar fact patterns. Therefore, it is highly recommended that in the event a taxpayer decides to take the position to depreciate its residual fertilizer upon acquisition of land, care should be taken by the taxpayer to follow the guidelines set forth in the PLR. Internal Revenue Code (IRC) Sections 180 and 175 provide tax planning opportunities for taxpayers to expense costs that too often end up being capitalized onto the balance sheet. It is important to note that even if the PLR guidance is followed exactly, until primary substantial authority exists and clearer guidance from the IRS is published, it is within their right for the IRS to take a contrary position to the published PLR that would disallow the depreciation of residual fertilizer.