What Was Section 182 of the Internal Revenue Code?
Understand the former Section 182 of the Internal Revenue Code, a repealed tax deduction for farm land clearing, and how these costs must now be capitalized.
Section 182 of the Internal Revenue Code was a provision that permitted taxpayers in the business of farming to deduct certain expenditures for clearing land. This rule allowed for the immediate recovery of costs associated with making land suitable for producing agricultural products.
The Repeal of the Land Clearing Deduction
The ability for farmers to deduct land clearing costs was eliminated by the Tax Reform Act of 1986. This legislative overhaul aimed to simplify the U.S. tax code by removing numerous special deductions and credits. The repeal of Section 182 was part of this broader effort to create more uniform rules for business expenditures and applied to all land clearing costs paid or incurred after December 31, 1985.
Provisions of the Former Law
When Section 182 was in effect, it allowed farmers to treat land preparation costs as currently deductible business expenses instead of capital expenditures. Qualifying activities included removing natural impediments like trees, stumps, and brush, as well as the treatment or movement of earth for leveling, conditioning, and terracing, and the diversion of streams and watercourses.
The deduction was subject to an annual cap. A farmer could deduct the lesser of $5,000 or 25% of the taxable income derived from farming for the year. Taxable income from farming was defined as the gross income from agricultural operations minus the deductions attributable to that business.
If a farmer’s land clearing expenditures exceeded this limit, the excess amount had to be capitalized. This meant the additional cost was added to the basis of the land and could not be deducted in that year.
Current Tax Treatment of Land Clearing Costs
Following the repeal of Section 182, the tax treatment for land clearing costs changed. Today, these expenditures must be capitalized, which means adding the costs to the tax basis of the land. The basis of an asset is its cost for tax purposes.
Unlike a deduction that reduces current taxable income, capitalized costs provide a tax benefit later. These costs are recovered when the land is sold. The capitalized expenses increase the owner’s adjusted basis in the property, which reduces the amount of taxable gain realized from the sale.
For example, if a farmer incurs $10,000 in clearing costs for a parcel of land, that amount is added to the property’s basis. When the land is later sold, the higher basis results in a lower calculated profit, which decreases the capital gains tax owed.