United States

IRS issues TCJA capitalization guidance for small business farmers

TAX ALERT  | 

Rev. Proc. 2020-13 answers many procedural questions for small business farmers related to the two choices available to not apply section 263A (commonly referred to as UNICAP) to plants with preproductive periods of more than two years.

Background

TCJA expanded the small business taxpayer exemption from UNICAP. Small business taxpayers include those other than a tax shelter that meet a $25 million gross receipts test. Prior to the expansion, section 263A(d)(3) generally allowed farmers with any plant with a preproductive period of more than 2 years to elect out of UNICAP. Plants with a preproductive period equal to or less than 2 years escaped the application of UNICAP. As a consequence of the farming specific election out of UNICAP, a taxpayer and any related party must apply the alternative depreciation system (ADS) rules for all property predominantly used in a farming business and placed in service in any taxable year during which the election was in effect. Property required to use ADS is ineligible for bonus depreciation and generally requires a longer recovery period as compared to the general depreciation system (GDS). Additionally, such election out of UNICAP requires section 1245 treatment for plants produced by the taxpayer and any gain resulting from any disposition of a plant is recaptured to the extent of the total amount of deductions that, but for the election, would have been required to be capitalized with respect to that plant.  

Taxpayers in a farming business that now qualify for the expanded exemption from UNICAP under TCJA no longer require the farming business specific exception. A farming taxpayer that properly elected to apply the exception under section 263A(d)(3) and applied ADS depreciation may seek a revocation of the election to avail themselves of the use of bonus depreciation and the shorter recovery periods available with GDS depreciation. Conversely, taxpayers that no longer qualify as small farming taxpayers may desire to make the farming specific election out of UNICAP for certain plants.

New Procedures for Small Taxpayers

Current year revocation

A taxpayer desiring to revoke its section 263A(d)(3) election in the current year must:

  1. Continue not to capitalize costs to plants produced in its farming business under section 263A; 
  2. Follow specific depreciation rules outline in the Rev. Proc.; and 
  3. Continue to treat plants as section 1245 property that are or have been treated as such property. 

The revocation must be made by a taxpayer on its original federal income tax return, including extensions. In the year of the revocation, in general, a change in use treatment applies for any existing property predominately used in any farming business of the taxpayer or related person.  For all newly acquired property placed in service in the year of revocation or subsequently, GDS and bonus depreciation applies, unless ADS is otherwise required. 

Late Revocation Options

If a taxpayer wants to revoke its section 263A(d)(3) election for the 2018 taxable year and take advantage of the favorable depreciation adjustments that may arise due to the revocation of the election, the taxpayer has two options –

(i) File an amended return or administrative adjustment request (AAR) for certain partnerships, or 

(ii) File a Form 3115, Application for Change in Accounting Method. 

A taxpayer may file an amended return for the 2018 taxable year before filing its federal income tax return for the first taxable year beginning after the 2018 taxable year. The amended return or AAR must include adjustments for the revocation of the 263A(d)(3) revocation and any collateral adjustment to taxable income. 

The guidance provides for a new automatic accounting method change that allows a taxpayer to revoke their section 263A(d)(3) election for its 2018 taxable year if the taxpayer files the change for its first, second, or third taxable year after the taxpayer’s first taxable year beginning in 2018. In general, the guidance allows for a section 481(a) adjustment related to the change in depreciation for the assets placed in service in 2018, but requires any property placed in service prior to the 2018 taxable year to follow the rules for changes in use. 

New Procedures for Former Small Business Farming Taxpayers 

If a farming taxpayer no longer qualifies as a small business taxpayer, the taxpayer may make the section 263A(d)(3) election for plants produced in its farming business in the first taxable year the taxpayer fails to qualify for the TCJA exception from UNICAP. To make the election, the taxpayer must – 

(i) Follow the existing regulations under section 263A for making the election under section 263A(d)(3), including the requirements related to ADS and section 1245 treatment, and 

(ii) Continue to not capitalize costs to the plants.

Insights:  Under either option, small business farming taxpayers do not have to apply section 263A for the production of plants with preproductive periods of more than two years.  Thus, the real crux of the guidance relates to the impact of the different options on the taxpayer or a related party’s depreciation of assets used predominately in the farming business.

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