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TITLE IV-AGRICULTURE, NATURAL RESOURCES, AND
A. Agriculture Provisions
1. Special expensing provisions: soil and water conservation; clearing land (secs. 401 and 402 of the Act and secs. 175 and 182 of the Code) 1
Expenditures for soil and water conservation
Under prior (and present) law, a taxpayer may elect to deduct certain expenditures for the purpose of soil or water conservation that would otherwise be added to the taxpayer's basis in the land on which the conservation activities occur (Code section 175). This deduction is limited in any one year to 25 percent of the gross income derived by the taxpayer from farming. Any excess amount is carried forward to succeeding taxable years.
Under prior law, expenditures deductible under section 175 included amounts paid for grading, terracing, and contour furrowing, the construction of drainage ditches, irrigation ditches, dams and ponds, and the planting of wind breaks. Also, assessments levied by a soil or water conservation drainage district were deductible under this provision to the extent those expenditures would have constituted deductible expenditures if paid directly by the taxpayer. The cost of acquiring or constructing depreciable machinery and facilities, however, were not eligible for expensing under this provision. In the case of depreciable items such as irrigation pumps, concrete dams, or concrete ditches, the taxpayer was allowed to recover costs only through cost recovery allowances, and only if the taxpayer owned the asset.
Expenditures for clearing land
Under prior law, a taxpayer engaged in the business of farming could elect to deduct currently amounts paid or incurred during the taxable year to clear land for use in farming (section 182). For any taxable year, this deduction could not exceed the lesser of $5,000 or 25 percent of the taxable income derived from farming.
Reasons for Change
Congress was concerned that certain Federal income tax provisions might be affecting prudent farming decisions. In particular,
1 For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, secs. 921-922, H. Rep. 99-426, pp. 649-651; H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, secs. 701-702; S. Rep. 99-313, pp. 264-265; Senate floor amendment, 132 Cong. Rec. S7827 (June 18, 1986); and H. Rep. 99-841, Vol. II (September 18, 1986), pp. 110-111 (Conference Report).
Congress was concerned that these provisions were contributing to an increase in acreage under production, which in turn encouraged the overproduction of agricultural commodities. Congress believed that to the extent possible, the tax code should be neutral with respect to these business decisions. To eliminate tax biases, therefore, Congress determined that certain of the special farming expensing provisions should be repealed or restricted.
Explanation of Provisions
Soil and water conservation expenditures
The Act limits the soil and water conservation expenditures that may be deducted currently to amounts incurred that, in addition to satisfying the requirements of prior law, are consistent with a conservation plan approved by the Soil Conservation Service (SCS) of the Department of Agriculture. If there is no SCS conservation plan for the area in which property to be improved is located, amounts incurred for improvements that are consistent with a plan of a State conservation agency are deemed to satisfy the Federal standards. Finally, the Act provides that expenditures for general earth moving, draining, and/or filling of wetlands, and for preparing land for installation and/or operation of a center pivot irrigation system may not be deducted under this provision.
Expenditures for clearing land
The Act repeals the provision of prior law that allowed expenditures for clearing land in preparation for farming to be deducted in the year paid or incurred. However, expenditures for routine brush clearing and other ordinary maintenance activities relating to property used in farming continue to be deductible currently, to the extent they constitute ordinary and necessary business expenses under sec. 162.
The amendment to the provision relating to soil and water conservation expenditures is effective for expenditures after December 31, 1986. The repeal of the provision relating to land clearing expenses is effective for expenditures after December 31, 1985.
These provisions are estimated to increase fiscal year budget receipts by $50 million in 1987, $37 million in 1988, $34 million in 1989, $33 million in 1990, and $32 million in 1991.
2. Dispositions of converted wetlands and highly erodible croplands (sec. 403 of the Act and new sec. 1257 of the Code)2
Under prior law, gain realized on the sale or other disposition of a capital asset was subject to tax at preferential rates. The term
* For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, sec. 923; H. Rep. 99-426, pp. 651-652; H.R. Continued
capital asset (under both prior and present law) does not include property used in a taxpayer's trade or business that is of a character subject to depreciation (sec. 1221(2)). However, gain from the sale of such property ("section 1231 assets") may be taxed on the same basis as gain from the sale of a capital asset if gains on all sales of section 1231 assets during a taxable year exceed losses on such sales.
If losses from the sale or exchange of section 1231 assets during a taxable year exceed the gains from such sales or exchanges, the net losses are treated as ordinary losses. Ordinary losses are deductible in full for tax purposes, while deductions for capital losses are subject to limitations.
Reasons for Change
Congress was concerned about the environmental impact of the conversion of the nation's wetlands and erodible lands to farming uses, and wished to discourage such conversions.
Explanation of Provision
Under the Act, any gain realized on the disposition of "converted wetland" or "highly erodible cropland" is treated as ordinary income, and any loss realized on the disposition of such property is treated as a long-term capital loss. For this purpose, the term "converted wetland" means land that is converted wetland within the meaning of section 1201(4) of the Food Security Act of 1985 (16 U.S.C. 3801(4)), provided such land is held by the person who originally converted the wetland, a person who uses the land for farming at any time following the conversion, or by a person whose adjusted basis in the property is determined by reference to the basis of a person in whose hands the property was converted wetland.* In general, the Food Security Act defines converted wetland as land that has been drained or filled for the purpose of making the production of agricultural commodities possible, if the production would not have been possible but for such action.
The term "highly erodible cropland" means any highly erodible cropland as defined in section 1201(6) of the Food Security Act of 1985 (16 U.S.C. 3801(6)) that is used by the taxpayer at any time for farming purposes other than the grazing of animals. In general, highly erodible cropland is defined as land that (1) is classified by the Department of Agriculture as class IV, VI, VII, or VIII land under its land capability classification system, or (2) that would have an excessive average annual rate of erosion in relation to the soil loss tolerance level, as determined by the Secretary of the Agriculture.
3838, as reported by the Senate Committee on Finance on May 29, 1986, sec. 703; S. Rep. 99-313, pp. 266-267; and H. Rep. 99-841, Vol. II (September 18, 1986), pp. 111-112 (Conference Report). Since other provisions of the Act (see Title III) eliminated the preferential rates applicable to individual and corporate capital gains, after 1986 the principal effect of this provision on gains is to prevent a taxpayer from offsetting the gains against capital losses.
Thus, land that has been converted could become eligible for section 1231 treatment in the hands of, for example, a subsequent purchaser or legatee, provided the purchaser or legatee has used the property only for nonfarming purposes.
The provision is effective for dispositions of converted wetland and highly erodible cropland first used for farming after March 1, 1986.
The provision is estimated to increase fiscal year budget receipts by a negligible amount.
3. Prepayments of farming expenses (sec. 404 of the Act and sec. 464 of the Code)5
Under prior (and present) law, a taxpayer generally is allowed a deduction in the taxable year which is the proper taxable year under the method of accounting used in computing taxable income (sec. 461). The two most common methods of accounting are the cash receipts and disbursements method and the accrual method. If the taxpayer's method of accounting does not clearly reflect income, however, the computation of taxable income must be made under the method which, in the opinion of the Internal Revenue Service, clearly reflects income (sec. 446(b)). Furthermore, the income tax regulations provide that if an expenditure results in the creation of an asset having a useful life which extends substantially beyond the close of the taxable year, such an expenditure may not be deductible, or may be deductible only in part, for the taxable year in which paid by a taxpayer using the cash receipts and disbursements method of accounting, or in which incurred by a taxpayer using the accrual method of accounting (see Treas. Reg. sec. 1.461-1(a)(1) and (2).)
Prior law was unclear as to the proper timing of a deduction for prepaid expenses other than interest. No specific statutory provision expressly permitted expenses to be deducted in full when paid by a taxpayer using the cash receipts and disbursements method of accounting. Such deductions were prohibited, however, to the extent that they resulted in a material distortion of income.
Generally, the courts examined all the facts and circumstances in a particular case to determine whether allowing a full deduction for the prepayment would result in a material distortion of income. In determining whether an expenditure resulted in the creation of an asset having a useful life extending substantially beyond the end of the taxable year, the court in Zaninovich v. Commissioner, 616 F.2d 429 (9th Cir. 1980), adopted a "one-year" rule. Under this rule, prepayments generally could be deducted if they did not provide benefits extending beyond one year. Thus, under this decision, it might be possible for a calendar-year, cash-basis taxpayer making a lease payment attributable to the following year to claim a deduction in the year of the payment.
5 For legislative background of the provision, see: H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, sec. 704; S.Rep. 99-313, pp. 267-270; and H.Rep. 99-841, Vol. II (September 18, 1986), p. 114 (Conference Report).
Certain cash method tax shelters may not deduct expenses before the time when economic performance occurs (e.g., when the goods are delivered or services performed). An exception is provided where economic performance occurs within 90 days of the end of the taxable year (sec. 461(i)(2)).
Special rules applicable to farming syndicates
Under prior law, certain limitations were imposed on deductions in the case of farming syndicates. A farming syndicate could deduct amounts paid for feed, seed, fertilizer, or other similar farm supplies only in the year in which such items were actually used or consumed or, if later, in the year such amounts were otherwise allowable as a deduction. A farming syndicate was defined generally as a partnership or any other enterprise (other than a corporation which was not an S corporation) engaged in farming if (i) interests in the partnership or enterprise were offered for sale in any offering required to be registered with any Federal or State agency or (ii) if more than 35 percent of the losses during any period were allocable to limited partners or limited entrepreneurs (i.e., persons who did not actively participate in the management of the enterprise).
Reasons for Change
Many farming tax shelters had been established to defer taxation of nonfarming income by prepaying farming expenses allocable to the following and subsequent years. Such tax shelters distorted the measurement of taxable incomes of their investors and affected farming operations that were not established for tax reasons. Congress believed that, in order to avoid these distortions, limits should be placed on the deductibility of prepaid expenses of certain farming tax shelters that did not fall within the definition of a farming syndicate.
Congress understood, however, that because of the seasonal nature of farming, numerous everyday business expenses are prepaid. Accordingly, the Act applies the limitations only to the extent that more than 50 percent of the farming expenses (exclusive of prepaid supplies) for the year are prepaid. In addition, in order to assure that farmers with continuous year-round or full-time farming activities are not subject to the limitations, the Act provides exceptions where a farmer has more than 50 percent prepaid expenses because of unusual or extraordinary circumstances. Congress believed that these rules will limit the application of the new restrictions to cases where the abuse is serious. In addition, Congress believed that the new rules will not impose any significant additional accounting burden on farmers.
Explanation of Provision
Under the Act, in the case of farmers eligible to use the cash method of accounting, the deductibility of prepayments for feed, seed, fertilizer, or other farm supplies may be limited in the same manner as prepayments made by a farming syndicate were limited