How to Calculate Farm Depreciation for Your Business

Depreciation is an annual income tax deduction that allows a farming or ranching business to recover the cost of certain property over its useful life. It represents the wear and tear, deterioration, or obsolescence of the asset. The purpose of depreciation is to match the cost of an asset to the income it helps generate over time, rather than deducting the entire cost in the year of purchase. This process helps manage taxable income from year to year.

By claiming depreciation, producers can reduce their net farm profit, which in turn lowers their overall tax liability. This accounting method applies to long-term assets expected to last for more than one year. The systematic deduction of an asset’s cost is a non-cash expense, meaning it reduces taxable income without an actual cash outlay in the current year.

Determining Depreciable Assets and Basis

First, a farmer must identify assets eligible for the deduction. Depreciable property includes items purchased for business use that have a determinable useful life of more than one year. Common examples include machinery like tractors and combines, equipment such as irrigation systems, and purchased livestock intended for draft, breeding, or dairy purposes. Fences, grain bins, and single-purpose agricultural or horticultural structures also qualify.

Certain assets are explicitly not depreciable, with the most significant being land. A personal residence on the farm is also not depreciable, although a portion may be if it is used exclusively for business as a home office. Raised livestock are not depreciable because the costs associated with raising them are deducted as current business expenses on Schedule F.

Next, the ‘basis’ of each asset must be established, which is the figure used to compute the annual depreciation deduction. For a purchased asset, the basis is its cost, including any additional amounts paid to put the asset into service. These can include sales tax, freight charges, and installation fees.

The ‘placed-in-service’ date must also be determined. This is the date the property is ready and available for its specific use in the farming business, not necessarily the date it was purchased. Depreciation begins from this date, which affects the timing and amount of the deduction in the first year.

Understanding Depreciation Systems and Methods

The primary system for calculating depreciation is the Modified Accelerated Cost Recovery System (MACRS). This system separates depreciable assets into classes and specifies the time period, or ‘recovery period,’ over which the cost of an asset can be deducted. It is designed to accelerate deductions, allowing for greater tax savings in the earlier years of an asset’s life.

Under MACRS, there are two subsystems: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). GDS is the most commonly used system for farm assets and allows for faster depreciation over a shorter recovery period. A farmer must use ADS for certain property or can elect to use it for any class of property, an irrevocable choice made on a class-by-class, year-by-year basis.

GDS assigns specific recovery periods to different types of farm property:

• Breeding hogs are 3-year property.
• Breeding or dairy cattle and light-duty trucks are 5-year property.
• Most farm machinery, equipment, and fences are 7-year property.
• Single-purpose agricultural or horticultural structures are 10-year property.
• Land improvements like drainage tiles are 15-year property.
• Farm buildings like barns and machine sheds are 20-year property.

Within GDS, farmers can often choose between the 200% or 150% declining balance methods. The 200% method offers the largest deductions in the early years. For 15- and 20-year property, the 150% declining balance method is required. A farmer can also elect to use the straight-line method, which spreads the deduction evenly over the recovery period.

Applying Special Depreciation Deductions

The Section 179 deduction allows a business to treat the cost of qualifying property as an expense and deduct it in the year the property is placed in service. This applies to most types of tangible personal property, such as machinery and equipment, as well as purchased livestock and single-purpose agricultural structures. For the 2024 tax year, the maximum amount that can be expensed is $1,220,000.

This expensing deduction begins to phase out if the total cost of qualifying property placed in service during the year exceeds an investment limit. The deduction cannot exceed the taxpayer’s net business income for the year, though any excess can be carried forward to future years.

Bonus depreciation, or the additional first-year depreciation allowance, is another provision. It allows deducting a percentage of the cost of qualifying new or used property in its first year of service. For property acquired and placed in service in 2024, the bonus depreciation rate is 60%.

This allowance is taken after any expensing deduction but before calculating regular MACRS depreciation. Qualifying property generally includes assets with a recovery period of 20 years or less, which covers most farm assets. Unlike the expensing deduction, there is no annual business income limitation for bonus depreciation, and farmers can elect out of it for each class of property.

Calculating and Reporting Depreciation with Form 4562

All depreciation is calculated and reported on IRS Form 4562, Depreciation and Amortization. This form is filed with the farm’s annual tax return, typically alongside Schedule F.

Part I is for the expensing deduction. You list the specific property you are electing to expense, its cost, and then calculate the final allowable deduction based on the dollar, investment, and business income limitations.

Part II covers the special depreciation allowance (bonus depreciation). This section is for assets that qualify for the allowance after any expensing deduction has been applied. You report the cost of qualifying property by its property class and calculate the bonus amount based on the applicable percentage.

Part III is for calculating regular MACRS depreciation on the remaining basis of assets. This section requires you to separate assets based on their recovery period. For each class, you will enter the basis for depreciation, the recovery period, and the depreciation method to find the regular deduction for the year.

Part IV is a summary that combines the deductions from all other parts to provide a total depreciation figure. Part V is used to list vehicles and other specified property, and Part VI is for calculating amortization on intangible assets. The total from Part IV is deducted as an expense on Schedule F.

Depreciation Recapture When Selling Farm Assets

Selling a depreciated business asset can trigger depreciation recapture. This rule requires that some or all of the gain realized from the sale be taxed as ordinary income rather than at more favorable capital gains rates. The amount of gain treated as ordinary income is limited to the total depreciation previously taken on the asset.

The rules for personal property, such as machinery, equipment, and purchased livestock, are covered by Section 1245 of the Internal Revenue Code. Under this rule, any gain on the sale is treated as ordinary income up to the full amount of depreciation that has been deducted. If the sale price exceeds the original cost of the asset, that portion of the gain is typically treated as a capital gain.

For example, assume a tractor was purchased for $100,000 and $60,000 in depreciation was claimed, reducing its adjusted basis to $40,000. If the tractor is then sold for $75,000, the total gain is $35,000. Because this gain is less than the total depreciation taken, the entire $35,000 is recaptured and taxed as ordinary income.

A different rule, Section 1250, applies to the sale of depreciable real property, such as a barn or other farm building. It typically only recaptures the amount of depreciation taken that is in excess of what would have been allowed under the straight-line method. Since MACRS for real property often requires the straight-line method, this form of recapture is less common for assets placed in service in recent decades, but a separate rule taxes the straight-line portion of the gain at a maximum rate of 25%.