A recent post by the Center for Agricultural Law and Taxation shed some light on the tax implications of various water quality measures including those addressing nitrogen reduction. Read the original version here.
Using the Iowa State University Publication, Reducing Nutrient Loss: Science Shows What Works as a guide, they reviewed a few common practices for their tax consequences and provided the general overview below.
One of the key strategies for reducing nitrate concentration in row crop farm ground is to plant cover crops. If a farm operator plants cover crops, they may deduct the cost of the seed and/or fertilizer as a trade or business expense in the year they plants the cover crop.[i]
Cost Share: Often, cost sharing programs are available to fund these practices. If a farmer receives an EQIP payment, for example, to cover the cost of the cover crops, that payment would be treated as ordinary income, subject to self-employment tax. Cost-sharing payments are only eligible for income exclusion under the tax code if the payment is not associated with a deductible expense.[ii]
Conservation Reserve Program (CRP)
Another option for improving water quality is to enroll targeted lands in CRP. Under this program, farm operators or landowners receive annual payments for contractually agreeing to keep enrolled acres out of production. CRP payments are typically reported as Schedule F Income, subject to self-employment tax. (more information)
Cost Share: Cost-share payments received under the CRP may be eligible for income exclusion to the extent permitted under IRC §126 (see full article).
Conservation easements can be an effective method of enhancing or maintaining water quality. These binding agreements implementing permanent land use restrictions can be purchased or donated or they may be implemented through a combination of both.
A purchased easement would include a Wetland Reserve Easement purchased by the Natural Resources Conservation Service (NRCS). Permanent and 30-year easements are treated for tax purposes like a sale of the property.
- The landowner would reduce his or her basis in the property in the amount of the purchase price of the easement.
- Any amount below zero would be IRC § 1231 gain reported on Form 4797. It is taxed at long-term capital gains rates as long as the property was owned for more than one year.
- Easement payments offered for easements in place less than 30 years are taxed as ordinary income.
- Easement payments are not subject to self-employment tax.
- Easements granted for 30 years or more can qualify for like-kind exchange treatment under IRC § 1031.
Landowners can also donate conservation easements for the purpose of improving water quality. Such an easement, for example, might allow for the implementation of a wetland on a portion of current crop ground. If tax code requirements are met, the landowner can claim the deduction as a charitable contribution and recognize significant tax savings. This is a complex area of tax law that requires the assistance of an experienced tax practitioner.
Saturated Buffers, Diversion Ditches, Filter Strips, Grade Stabilization, Terraces
Active farmers may be able to presently deduct the cost of conservation practices implemented as part of an NRCS (or comparable state)-approved plan.
The IRC § 175 soil and water conservation deduction (which is taken in the year the improvements are made) can be elected for conservation expenditures in an amount up to 25 percent of the farmer’s gross income from farming. The deduction can only be taken for improvements made on “land used for farming.” Excess amounts may be carried forward to future tax years.[ix]
Those who cash rent their ground) must capitalize these expenses (add the cost of the improvement to the basis of the property) because the IRC § 175 deduction only applies to taxpayers “engaged in the business of farming.”
Cost share: Cost sharing or incentive payments received to implement these conservation programs would be taxed as ordinary income.
Drainage Water Management
Drainage tile modifications or installations are generally depreciable over a 15-year period. This should include the cost of most water control structures that are part of the system and the cost of the installation. Farming operators would also be eligible for IRC § 179 expensing and 50 percent bonus depreciation for the cost of new tile installation. Non-farming landowners could also depreciate the cost of the drainage tile improvements over a 15-year period. Although they would not be eligible for IRC § 179 expensing (since they are not in the business of farming), they would be eligible for 50 percent bonus depreciation for the cost of new tile.
Cost share: Cost sharing or incentive payments would be taxed as ordinary income, unless determined to be excluded from income under IRC § 126. This might be especially useful for non-farming landowners not eligible for IRC § 179 expensing.
Bioreactors have become a very popular tool for removing significant amounts of nitrates from water passing out of a drainage tile system. These structures can cost thousands of dollars and don’t increase production or otherwise improve the bottom line of a farming operation. As such, economic incentives to implement bioreactors are particularly important.
A bioreactor does not show up on any MACRS table. It would likely be depreciated over a seven-year period. Materially participating producers installing a bioreactor would be eligible for Section 179 and 50 percent bonus depreciation. Non-farming landowners could likely depreciate the cost of the bioreactor over a 7-year period (as equipment) and would be eligible for 50-percent bonus depreciation.
Cost share: Cost sharing or incentive payments could likely be excluded under IRC §126.This might be especially useful for non-farming landowners not eligible for IRC § 179 expensing.
To read the full article visit https://www.calt.iastate.edu/taxplace/tax-treatment-water-quality-measures-farm-operators-and-landowners. For questions, contact the author Kristine Tidgren at 515-294-6365 or firstname.lastname@example.org.