How Reclassifying Expenses can Improve your Farm’s Financial Health

Key Takeaways:
  • Capitalizing repairs can spread deductions over several years, providing tax relief and better cash flow management.
  • Combining capitalizing repairs with Section 179 and farm income averaging can significantly reduce your tax burden.
  • Schedule F farmers can use capitalizing repairs to offset future income, lowering self-employment taxes.

 

With rising costs in repairs and maintenance, it’s important to explore alternative methods to make the most of every dollar you spend. One such strategy is capitalizing repairs, which can provide significant tax benefits and help you manage your farm’s finances more effectively. 

What is Capitalizing Repairs? 

Capitalizing repairs involves reclassifying the total repair expense as a fixed asset on the balance sheet, thereby removing the full repair expense from the profit and loss statement. When repairs are expensed, they provide a deduction toward the current year’s income. However, as commodity prices fluctuate and trade costs remain high, many farmers may face losses in a given year. By capitalizing repairs, you can potentially gain a tax benefit by spreading the deduction over several years. 

How Does it Work? 

When repairs are capitalized, they are depreciated over a period of seven years. This means instead of deducting the entire repair cost in the current year, you can deduct a portion of it over the next seven years. For instance, if you have $70,000 in repairs, you could deduct $10,000 annually for the next seven years. This approach extends the tax benefit over a longer period, providing a more balanced financial impact. 

Tax Benefits of Capitalizing Repairs 

The primary benefit of capitalizing repairs is its potential to provide tax relief in years when you incur a loss. However, this method is not limited to loss years alone. If you have taxable income, capitalizing repairs can help you maximize lower tax brackets, especially when combined with farm income averaging. 

Farm income averaging allows you to spread your income over the previous three years, which can be particularly beneficial in a good year that might otherwise push you into a higher tax bracket. By using both strategies together, you can effectively minimize your overall tax burden. 

Capitalizing Repairs & Section 179 

Another powerful tool in your tax strategy arsenal is Section 179. This tax incentive allows you to deduct the cost of certain assets up to a specific amount from your taxes. When combined with capitalizing repairs, Section 179 can provide substantial tax savings. 

Benefits for Schedule F Farmers 

Farmers filing a Schedule F on individual returns can also benefit significantly from capitalizing repairs. Schedule F farmers are subject to self-employment taxes on farm income. In cases where your farm shows a loss, capitalizing repairs allows you to save those deductions to offset self-employment income in future years. This can create a more beneficial deduction and help reduce your overall tax burden. 

While capitalizing repairs and other tax strategies can provide substantial benefits, it’s recommended to consult with an agriculture tax advisor to determine the best approach for your specific situation. Tax laws and regulations can be complex, and a knowledgeable advisor in the farming industry can help you navigate these complexities to achieve the most favorable outcome. Contact a member of the Adams Brown agriculture team to discuss further.