W-2 Income Tax Deductions from Farming and Ranching
If you have W-2 income, what tax deductions are fair game to shelter some of it?
Well, of course, we are well beyond talking about the hobby rules here; you have legitimate business interests in agriculture. Perhaps you are a physician or other high-income W-2 professional who has some ties or Ag roots. Put them to use to depreciate away your income now and turn them into cash-flowing assets.
Does that sound familiar? High-income W-2 turns income into section 179 and bonus depreciation? It sounds like taking active W-2 wages and turning them into business income, or, even perhaps more similar, using them against active real estate gains.
If you want the bible from the IRS, go no further than the IRS Publication 225 (Farmer’s Tax Guide).
But for a shortcut, here is a guide on deducting your W-2 income with Farming and Ranching.
The Guide to Farming and Ranching Tax Deductions for the High-Income W-2 Earner
So, let’s get right to it. This is the guide to farming and ranching tax deductions for the high-income W-2 earner. What are some tax-related issues you need to keep in mind:
- Remember, you will accelerate income some years, and some years, you will defer income.
For the W-2 worker, you will use this tax bracket arbitrage as an opportunity to fund Roth accounts during low-income years.
With your farm and ranch income, you can have significant tax deductions for necessary business expenses this year, last year, or next year.
My outfit up on top with fencing supplies in the back. You will walk miles with a bucket fixing a thing or two every now and again and then come across a 100ft section that needs rebuilt after snow drifts, erosion, or, most likely, 100+-year-old posts falling down due to age. The outfit and supplies are a business deduction at 100% in the year of purchase. So I might buy some extra that I need next year and take the deduction this year, or I might not.
- Farm Income Averaging
W-2 earners might also adjust tax burden by using the income averaging election for farmers election.
- Depreciation for Farmers and Ranchers
- Section 179 or bonus depreciation for most pieces of new equipment. This phases out above $2M
- New buildings may be rapidly depreciated via cost segregation, with the rest depreciated over 20 years. Note some structures are ten years.
Going down the 18% grade in Low 4WD in first gear. In front of me, a 7000lb skid steer is strapped to a flattop that essentially sides down parts of the greasy bentonite trail. Going up, we had to unhitch the skid steer and move it forward 10 feet to get more weight on the truck. Backing down the hill to gain momentum after unstrapping and driving a skid steer while on a flatbed at 18 degrees was just a routine part of the day. That’s an expensive piece of equipment. I can section 179 deduct it 100% this year if I need a new one.
- Pay Kids for Tax Deduction and Roth
This may be a complicated topic, but having a farm or ranch provides ample room to employ your kids, get the business tax deduction, and use their income to fund Roth IRAs for them. Of course, this is age, State, and child-dependent.
- Federal and State Fuel Tax Credit
If you want to keep track of the number of gallons of fuel you use on the place and not the road.
- Carry Back Losses and W-2
It would be nice to carry back losses with W-2 income, but alas, there is no way. With farm and ranch income, you can carry back net operating loss for two years. Losses can be carried forward indefinitely. However, losses can only offset 80% of taxable income. There are also difficult decisions with the 199A deduction to take into account. And, of course, the excess business loss rule limits a loss to $500k a year.
- Use Retirement Accounts
Why not use Solo-K’s, SEP-IRAs, HSA’s, etc.?
W-2 Income Into Assets via Farming and Ranching
So, remember, the goal is not losses or unnecessary expenses; it is to turn money you would otherwise blow on taxes into assets that work for you.
Land, tractors, equipment, buildings, improvements, housing, employment, business-related items, cell phones, computers… there are a lot of things that your farm or ranch will need.
Similar to running a business or in real estate, the idea is to defer gains to the future. But, then, the game is never to pay them.
High W-2 Income and IRS Targets
High W-2 income with Schedule F expenses that a legimitit business interests cannot explain might become a target of IRS audit.
While both businesses and hobbies might have start-up costs that get deducted, business or enjoyment will determine the next 3 out of 5 years’ business revenues and future deductions.
Tax Treatment of Sales of Products
Income from the sale of products raised and sold is reported on line 2 of Schedule F.
This includes animal, vegetables, and other ag products, and expenses for raising these are deducted in the year of occurrence.
Above, my cow and her white-faced calf. In front are two of her playmates up on top of the summer pasture. The cow is 100% depreciated long-term capital gain asset if sold, and her bull calf is ordinary income since he was born on the place.
Crop or Livestock Share rental income for materially participating is also reported on line 2 of Part 1 of Schedule F. This is a fascinating idea for the right W-2 earner. Use Schedule J to make the income-averaging election.
Summary- Farming and Ranching Tax Deductions with W-2 Income
Typical country for fencing. The original fence from more than 100 years ago is largely present. Posts were cut locally, and holes dug before 3 or 4 wire fences were strung along miles of peaks and cliffs and sheer drop-offs due to long-term local erosion of the country. This is high desert and a really green year for grass. The grasshoppers ate all last year’s grass, so all you see is new growth, sage, and juniper (the source of the old posts).
So, if you have high W-2 income, you can turn some of the money you were going to pay as taxes into assets that can cash flow for you.
Remember, this is a business. So there will be business expenses that can offset your non-farm and non-ranch W-2 income. Or your spouse’s W-2 income. Nice idea!
Finally, take a look at the picture way back up on top. This land was all homesteaded. You can see they pulled rocks from the gully several hundred feet away for a foundation. That gully also likely had a spring that is now dried up but was the reason for the homestead to be located there in the first place. The homestead failed as the land’s best use is cattle, not farming. They say land always goes to its best use. Eventually. That’s a little like tax money. You can pay it today, or you can turn it into assets through depreciation.