August 13, 2020

Business expenses are tax-deductible, or at least they usually are. The Internal Revenue Code (IRC) does not allow the deduction of some business-related expenditures. The Uniform Capitalization (UNICAP) rules, for example, require businesses to capitalize certain expenses, or include them in inventory costs. This can present disadvantages in terms of tax liability. The IRC makes an exception for farm businesses, although this may come with additional rules regarding depreciation that may have their own disadvantages. The Tax Cuts and Jobs Act (TCJA) of 2017 amended the IRC to allow other businesses to opt out of the UNICAP rules, but without being subject to the special depreciation rules. In early 2020, the IRS released guidance on how farming businesses can use the new exemption provided by the TCJA.

What Are the Uniform Capitalization Rules?

Under § 263A of the IRC, certain expenses must be capitalized or treated as inventory costs. The UNICAP rules apply to direct and indirect costs associated with real or personal property that is “produced by the taxpayer,” or that is acquired as a capital asset for the purpose of resale. These rules are significant in capital-intensive businesses like real estate. Direct costs include materials and labor directly involved in development or construction. Indirect costs arise from similar activities that benefit a property.

How Do the UNICAP Rules Apply to Farmers?

Section 263A(d)(1) exempts farmers from the UNICAP rules altogether for livestock and plants with “a preproductive period of 2 years or less.” The IRS periodically publishes a list of plants that fit this description. The most recent list, published in 2013, includes apples, coffee beans, grapes, lemons, olives, oranges, and walnuts.

Under § 263A(d)(3), farmers with annual gross receipts of no more than $25 million may opt out of the UNICAP rules for all plants produced, regardless of their preproductive period. Sections 263A(e)(1) and (2) impose two additional requirements on farmers that opt out. The farmer must treat any plant whose expenses would have otherwise been capitalized as “section 1245 property,” meaning that the amount of gain that can be realized will be limited. They must also use the “alternative depreciation system” (ADS) described in IRC § 168(g)(2) for all property used in farming activities.

What Changes Did the 2017 Tax Reform Bill Make?

Section 13102(b) of the TCJA amended IRC § 263A(i) to allow businesses with annual gross revenues of $25 million or less to opt out of the UNICAP rules. Unlike § 263A(b)(3), this exemption is not limited to farming businesses and does not include provisions regarding § 1245 or the ADS.

What Is the IRS’s Guidance for Farmers?

In February 2020, the IRS issued Rev. Proc. 2020-13 to provide farm businesses with guidance on how to revoke their election under § 263A(b)(3) and choose the exemption under § 263A(i). This may involve filing an amended return or a Form 3115 with a new return. Farming businesses must also follow procedures set out by the IRS for adjusting their depreciation of assets.

If you need assistance with a tax-related matter, please contact the Enterprise Consultants Group today online or at (800) 575-9284. Our tax advisors are available to answer your questions and address your concerns.