! THE VALUE OF ACCELERATED DEPRECIATION USE BY FARMERS: EVIDENCE FROM MICHIGAN By Leonard Lloyd Polzin A THESIS Submitted to Michigan State University in partial fulfilment of the requirement for the degree of Agricultural, Food and Resource Economics Ð Master of Science 2016 !ABSTRACT THE VALUE OF ACCELERATED DEPRECIATION USE BY FARMERS: EVIDENCE FROM MICHIGAN By Leonard Lloyd Polzin In 1981 the IRS tax code created Section 179 depreciation deductions. Section 179 was a form of accelerated depreciation, allowing farmers to deduct a larger amount of depreciation in the year an asset was placed in service. In 2002 ÒBonusÓ depreciation was added as another form of accelerated depreciation available to farm tax filers. Both forms of accelerated depreciation allowed farmers to take large amounts of depreciation in the first year relative to the default tax depreciation known as the Modified Accelerated Cost Recovery System (MACRS). These accelerated depreciation deductions allowed farmers to decrease their taxable income, thus saving them money and incentivizing investment. The objectives of this thesis are to examine: which farms use accelerated depreciation, when and how much they use it; what is the after tax present value of accelerated depreciation deductions; and what is farmers realized decreased cost of capital from these tax policies and implications for investment. This research finds that the after tax present value of accelerated depreciation deductions revealed significant values across all farm types and asset classes. Because of accelerated depreciation use farmers realized decreased cost of capital from accelerated depreciation tax policies. Finally, farmer investments were most responsive in 7 and 10 year property from accelerated depreciation use. !"""! This thesis work is dedicated to my wife and family for their continued love and support. A special feeling of gratitude to my wife, Teal, who has been there for me throughout the challenges of graduate school and life. I am thankful for having you in my life. !"#!ACKNOWLEDGMENTS I would first like to thank my thesis advisor Dr. Christopher Wolf for the immense time, effort and energy he graciously shared with me. The door to Dr. WolfÕs office was always open when I had questions or ran into a problem. I would also like to thank the additional members of my committee, composed of Dr. J. Roy Black and Dr. Timothy Harrigan for their guidance during the research process. I truly appreciate the attention and guidance everyone was willing and able to provide over the course of this project. !#!TABLE OF CONTENTS LIST OF TABLES .........................................................................................................................vi Chapter 1. Introduction ...É...ÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉ.....ÉÉÉÉ1 Chapter 2. Depreciation and Farm Income Tax Management ÉÉÉÉÉ........ÉÉÉÉÉÉÉ4 2.1 Tax Policy History.........................................................................................................4 2.2 Depreciation Examples................................................................................................12 Chapter 3. Data and Summary Statistics ÉÉÉÉÉ......ÉÉÉÉÉÉ......ÉÉÉÉÉÉÉ...22 3.1 Farm Size ÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉ.ÉÉÉÉÉÉÉ.22 3.2 Income Tax Depreciation ...ÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉ...29 3.3 Bonus Depreciation Carryover Basis ÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉ42 Chapter 4. Analyzing the Farm Effects of Accelerated Depreciation É.....É...É..É...É.É....47 4.1 Value of Depreciation Allowances ÉÉ...ÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉ47 4.2 Section 179 Present Values ÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉ...51 4.3 Bonus Depreciation Present Values ÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉ..54 4.4 Cost of Capital ÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉÉ......................57 4.5 Effect on Investment .............................................................................................70 CHAPTER 5. Summary and Conclusions ....................................................................................72 APPENDIX ...................................................................................................................................74 REFERENCES............................................................................................................................127 !#"!LIST OF TABLES Table 2.1 History of Accelerated Depreciation Tax Policy.............................................................5 Table 2.2 Farm Property and Recovery Periods..............................................................................8 Table 2.3 MACRS GDS Percentage Table ...................................................................................11 Table 2.4 Example of MACRS GDS 150% Declining Balance Method .....................................13 Table 2.5 Section 179 Investment and Expense Deduction Limitations and Bonus Deduction, 2004-2014 .....................................................................................................................16 Table 2.6 Example of Section 179, Bonus and Joint Use of Accelerated Depreciation Deduction .....................................................................................................................18 Table 2.7 Order of Accelerated Depreciation Election .................................................................21 Table 3.1 Gross Farm Income by Farm-Type, 2004-2014............................................................22 Table 3.2 Frequency of Gross Farm Income.................................................................................23 Table 3.3 Gross Farm Income by Farm-Type and Year................................................................24 Table 3.4 Schedule F, Net Farm Profit or Loss by Farm-Type.....................................................25 Table 3.5 Frequency of Schedule F, Net Farm Profit or Loss ......................................................25 Table 3.6 Schedule F, Net Farm Profit or Loss by Farm-Type and Year......................................26 Table 3.7 Acres Operated by Farm-Type......................................................................................27 Table 3.8 Frequency of Acres Operated .......................................................................................27 Table 3.9 Acres Operated by Farm-Type and Year.......................................................................28 Table 3.10 Pairwise Correlation of Size Variables........................................................................29 Table 3.11 Depreciation Summary Statistics Not Conditional on Accelerated Depreciation Use.................................................................................................................................30 Table 3.12 Summary Statistics of Section 179 Use Conditional on Election of Section 179 Depreciation Deduction.................................................................................................30 !#""!Table 3.13 Frequency and Average Amount of Section 179 Depreciation Deduction Taken by Year and Farm-Type, Conditional on Section 179 Use................................................31 Table 3.14 Section 179 Use by Asset Class...................................................................................32 Table 3.15 Section 179 Use by Asset Class, Farm-Type and Year...............................................33 Table 3.16 Frequency of Farm Investment, Eligibility for Section 179 Direct Expensing and Section 179 Depreciation Deduction Taken by Asset Class.........................................34 Table 3.17 Average of Investment, Amount Eligible for Section 179 Direct Expensing and Section 179 Depreciation Deduction Taken by Asset Class.........................................35 Table 3.18 Summary Statistics of Bonus Depreciation Conditional on Elected Bonus Depreciation Deduction.................................................................................................37 Table 3.19 Frequency and Average Amount of Bonus Depreciation Deduction by Year and Farm-Type.....................................................................................................................38 Table 3.20 Frequency of Bonus Use by Asset Class, 2004-2014..................................................39 Table 3.21 Bonus Use by Asset Class by Farm-Type and Year....................................................40 Table 3.22 Frequency of Bonus Depreciation Taken as a Percent of Investment.........................41 Table 3.23 Average Investment and Bonus Depreciation Deduction Taken by Class..................42 Table 3.24 Bonus Depreciation on Carryover Basis Example......................................................45 Table 4.1 Example of Section 179, Bonus and Joint Use of Accelerated Depreciation Deduction .....................................................................................................................48 Table 4.2 Summary Statistics of Accelerated Depreciation After-Tax Present Values ...............50 Table 4.3 After Tax Present Value Summary Statistics of Section 179 Depreciation Deduction .....................................................................................................................51 Table 4.4 After Tax Present Value of Section 179 Summary Statistics by Farm-Type and Asset Class .............................................................................................................................53 Table 4.5 After Tax Present Value Ratio of Section 179 Depreciation Deductions .....................53 Table 4.6 After Tax Present Value Summary Statistics of Bonus Depreciation Deductions .......55 Table 4.7 After Tax Present Value Bonus Depreciation Summary Statistics by Farm-Type and Asset Class ...................................................................................................................56 !#"""! Table 4.8 After Tax Present Value Ratio of Bonus Depreciation Deductions Taken ..................56 Table 4.9 Average Present Value Depreciation Rates by Class and Recovery Period for MACRS and Accelerated Depreciation Tables ...........................................................................60 Table 4.10 Average Present Value Depreciation Rates by Class and Recovery Period for Section 179 and Bonus Depreciation Tables .............................................................................61 Table 4.11 Summary Statistics for Cost of Capital with MACRS DepreciationÉ.......................62 Table 4.12 Cost of Capital by Class for Accelerated Depreciation UseÉ....................................63 Table 4.13 Cost of Capital by Asset Class for Section 179 and Bonus Depreciation DeductionsÉ............................................................................................................É.64 Table 4.14 Cost of Capital by Farm-Type and Asset Class for Section 179 Depreciation DeductionsÉ...........................................................................................................É..65 Table 4.15 Cost of Capital by Farm-Type and Asset Class for Bonus Depreciation DeductionsÉ............................................................................................................É.65 Table 4.16 Cost of Capital by Asset Class Across Years for MACRS DepreciationÉ................66 Table 4.17 Cost of Capital by Asset Class Across Years for Section 179 Depreciation Deductions TakenÉÉ................................................................................................................É.66 Table 4.18 Cost of Capital by Asset Class Across Years for Bonus Deduction Deductions TakenÉÉ.............................................................................................................ÉÉ66 Table 4.19 Average Cost of Capital by Depreciation TypeÉ...........................................ÉÉÉ67 Table 4.20 Average Cost of Capital by Depreciation Type: Internal ROE of 6-11%...................69 Table 4.21 Investment Responses Relative to MACRS DepreciationÉ.............................ÉÉ..70 !$!Chapter 1. Introduction In 1981, the IRS tax code created Section 179 depreciation deductions. Section 179 was a form of Accelerated depreciation deductions, allowing farmers to deduct a larger amount of depreciation in the year an asset was placed in service. In 2002 ÒBonusÓ depreciation was added as another form of Accelerated depreciation available to farm tax filers. Both forms of Accelerated depreciation allowed farmers to take large amounts of depreciation in the first year. These deductions allowed farmers to decrease their taxable income, thus saving them money and incentivizing them to increase investments. The effect of this accelerated depreciation on farm investment and management decisions has remained unexamined to date. There have been many papers looking at tax policy and investment behavior (Edwards and Boehlje, 1980; Reid and Bradford, 1987; Reid et al., 1980; Weersink and Stauber, 1988). To date, none of which have ever looked at a panel of firms and investigated the benefit of utilizing these deductions across all classes of investments. Many researchers have looked at the use of these policies on individual assets. Due to the lack of data, some authors have made assumptions about Accelerated depreciation deductions. These assumptions often incorrectly interpret the mechanics of the IRS tax code and overlook important the details of Accelerated depreciation use. This thesis highlights the complexities of Accelerated depreciation deduction elections and disaggregates tax policies effects. Hall and Jorgenson (1967) found that ÒThe effects of Accelerated depreciation are very substantial, especially for investment in structures.Ó They go on to state that: Our basic conclusion is that tax policy is highly effective in changing the level and timing of investment expenditures. In addition, we find that tax policy has had important effects on the composition of investment. According to our estimates, the !%!liberalization of depreciation rules in 1954 resulted in a substantial shift from equipment to structures. The finding that tax policy changes the composition of investments further justifies looking at Accelerated depreciation use over a portfolio of investments. This approach of investigation becomes self-evident once a greater understanding of Section 179 and Bonus depreciation deductions incentive structures are realized. Additional motivation for this research originates in Chisholm (1974) who found that increased levels of depreciation encouraged investment behavior. Kay and Rister (1976) calculated the present values for each possible replacement year instead of using ChisholmÕs marginal criteria. Kay and Rister found that while Accelerated depreciation did not have as large an effect on optimal replacement age as expected, it did affect the present value of investment. Ariyaratne and Featherstone (2009) found that when looking at 811 Kansas farm business from 1998 to 2007, the addition of machinery and equipment and listed property depreciation created a strong determinate for investment decisions. House and Shapiro (2008) estimated the investment supply elasticity and found that investment in qualified capital increased sharply with the use of Accelerated depreciation. While this paper does not attempt to explain directly drivers of investment, these previous works dictate the importance of understanding the benefits farmers have received from the addition and expansion of Accelerated depreciation tax policies. The dataset used in this research is unique in its detail and inclusion of financial and tax depreciation information. The set spans 11 years and 7 Section 179 depreciation and 4 Bonus depreciation deduction policy changes. This thesis does not try to explain investment behavior or factors influencing purchases. It carefully examines the use of Accelerated depreciation by asset class, year and farm type and measures the benefits farmers have received from these !&!policies. By examining actual, farm-level behavior, this research addresses a gap in the existing literature. The objective of this thesis is to answer the questions of (1) what is the after-tax present value of Accelerated depreciation deductions and (2) what is farmers realized decreased cost of capital from these tax policies. A present value model as presented in Kay and Rister (1976) is used to evaluate Accelerated, Section 179 and Bonus depreciation deductions. The cost of capital model as proposed by Hall and Jorgenson (1967), is used to determine the changes in the opportunity cost of investments given policy changes. The results have policy implications including whether and how much accelerated depreciation is encouraging farm investment. The next chapter examines the history of Accelerated depreciation policies for farm managers. Chapter 2 also considers the mechanics of farmer choice when using Accelerated depreciation compared to the default depreciation method. Chapter 3 examines the panel dataset of Michigan farms. Summary statistics on taxable farm income, investment, and depreciation choices by year, class and farm type are examined. These statistics reveal the relative frequency and magnitude of Accelerated depreciation use. Chapter 4 calculates the present value of Accelerated depreciation relative to default IRS depreciation by year, class and farm type. The effect of Accelerated depreciation on the cost of capital is examined using the model from Hall and Jorgensen (1967). The reduction in the cost of capital has implications for investment. Finally, Chapter 5 summarizes and concludes. !'!Chapter 2. Depreciation and Farm Income Tax Management 2.1 Tax Policy History In 1942, the U.S Treasury created an item-by-item listing of useful asset lives for over 5,000 types of assets used in 57 different industry activity categories in what was known as Bulletin F (Office of Tax Analysis, U.S. Treasury Department, 1989). These useful asset lives became the de facto standard for depreciation deductions, which could be refuted only by substantial evidence produced by the taxpayer (Office of Tax Analysis, U.S. Treasury Department, 1989). In the 1954 Code, Congress authorized accelerated methods of depreciation, called accelerated cost recovery system (ACRS), to encourage businesses to increase investment in depreciable assets. The primary motive behind the introduction of the accelerated methods in 1954, however, was to provide a permanent investment incentive (Office of Tax Analysis, U.S. Treasury Department, 1989). The Senate Finance Committee reported, ÒMore liberal depreciation allowances are anticipated to have far-reaching economic effects. The incentives resulting from the changes are well timed to help maintain the present high level of investment in plant and equipment. The acceleration in the speed of the tax-free recovery of costs is of critical importance in the decision of management to incur risk. The faster tax write-off would increase available working capital and materially aid growing businesses in the financing of their expansion. For all segments of the American economy, liberalized depreciation policies should assist modernization and expansion of industrial capacity, with resulting economic growth, increased production, and a higher standard of living (U.S. Congress (1954), p. 26).Ó !(! Before this, only straight line depreciation was used. Straight line depreciation, calculated as [cost-salvage value]/useful life, allocates equal amounts of depreciation each year. ACRS depreciation originally utilized 200% declining balance (DB) and had an alternate option of depreciation utilizing fixed percentages for each class of property annually. In 1962, the IRS abandoned Bulletin F for asset classes, which are still in use today. In 1986, congress modified ACRS and renamed it the modified accelerated cost recovery system (MACRS). The change to MACRS extended the recovery period of assets and consisted of two depreciation systems, the General Depreciation System (GDS) and Alternative Depreciation System (ADS). These systems are still used today, provided different methods and recovery periods used in calculating depreciation expense. To better display the history of these tax policies table 2.1 is below. Table 2.1 History of Accelerated Depreciation Tax Policy Tax Year What it Was What it Did Method of Depreciation 1942 Bulletin F Listing of asset lives SL 1954 Accelerated Cost Recovery System (ACRS) Created accelerated methods of depreciation 200% DB/SL 1962 Asset Classes Abandoned Bulletin F 1981 Creation of Section 179 Allowed for additional 1st year depreciation Maximum investment and maximum expense limitation 1986 Modified ACRS (MACRS) Extended recovery periods, and created GDS and ADS ADS=SL GDS=200% DB, 150% DB and SL 1988 Farm property limited to 150%DB Standardized depreciation method GDS=150%DB ADS=SL 2002 Creation of Bonus Depreciation (Sec 168(k)) Allowed for additional 1st year depreciation Percent of depreciable basis !)!GDS periods are shorter compared to ADS periods. MACRS provides three depreciation methods under GDS and one depreciation method under ADS. GDS options include the 200%, straight line depreciation rate * 2, and 150%, straight line depreciation rate * 1.5, declining balance (DB) methods and the straight line method over the GDS recovery periods. ADS allows only the straight line method. Under the 150 and 200% DB methods, taxpayers change from declining balance to straight line at the point when straight line deductions are larger. Depreciation on farm property placed in service after 1988 is limited to 150% declining balance unless tax law states otherwise. Once GDS or ADS is elected to be used on an asset, the asset must remain in that depreciation system for its entire depreciable life. According to the IRS Publication 225, FarmerÕs Tax Guide, 2014, p. 41: ÒYour (farmers) use of either GDS or ADS to depreciate property under MACRS determines what depreciation method and recovery period you use. You generally must use GDS unless you are specifically required by law to use ADS, or you elect to use ADS. Required use of ADS. You must use ADS for the following property. ¥!All property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect. ¥!Listed property used 50% or less in a qualified business use. ¥!Any tax-exempt use property. ¥!Any tax-exempt bond-financed property. ¥!Any property imported from a foreign country for which an Executive Order is in effect because the country maintains trade restrictions or engages in other discriminatory acts. !*!¥!Any tangible property used predominantly outside the United States during the year. If you are required to use ADS to depreciate your property, you cannot claim the special depreciation allowance.Ó The IRS allows farms to depreciate most types of tangible business property except land. This includes such things as buildings, machinery, equipment, vehicles, land improvements and breeding livestock. According to IRS Publication 225, FarmerÕs Tax Guide, 2014, p. 35: ÒTo be depreciable the property must meet the following requirements: ¥!It must be property the business owns. ¥!It must be used in the business. ¥!It must have a determinable useful life. ¥!It must be expected to last more than one year.Ó Table 2.2 displays frequently used agricultural property and the associated recovery periods for GDS and ADS. For a complete list of recovery periods, see the Table of Class Lives and Recovery Periods in Appendix B of Publication 946 (IRS Publication 225, FarmerÕs Tax Guide, 2014, p. 41). !+!Table 2.2 Farm Property and Recovery Periods Assets GDS ADS Years Tractor units (over-the-road, ie: semi-trucks) Hogs (breeding) Horses (breeding and working, more than 12 years) Automobiles Cattle (dairy or breeding) Goats and sheep (breeding) Logging machinery and equipment Truck (13,000 lbs or more) Truck (less than 13,000 lbs) Alternative energy Farm machinery and equipment Fences (agricultural) Grain bin Horses (12 yrs or less) Horticultural structures (single purpose) Agricultural structures (single purpose) ¥!Manure pit Drainage facilities Paved lots Water wells, irrigation well, well house Land Improvements ¥!Culvert ¥!Ditch ¥!Drive, road, gravel ¥!Lagoon (not manure pit) ¥!Land clearing, pond ¥!Tile and erosion structure Farm buildings (not single purpose) 3 3 3 5 5 5 5 5 5 5 7 7 7 7 10 10 15 15 15 15 20 4 3 10 5 7 5 6 6 5 12 10 10 10 10 15 15 20 20 20 20 25 !,!To be able to depreciate an asset, the asset must be placed in service the date of which determines the applicable convention. These conventions simplify the depreciation process because they do not require the filer to prove when the property was placed into service. For farmers, a half-year convention applies meaning all property is assumed placed into service was at the midpoint of the year. The farmer then claims a half-year of depreciation on newly acquired property. This results in a half-year amount of depreciation claimed in the last year of depreciation, accounting for the remaining depreciable basis not claimed in the initial purchase year (IRS Publication 225, FarmerÕs Tax Guide, 2014). The depreciable basis is the amount of deduction the farmer can claim over the useful life of the asset. IRS Publication 225, Farmers Tax Guide, 2014 describes basis for depreciation by: ÒThe basis for depreciation of MACRS property is the propertyÕs cost or other basis multiplied by the percentage of business/investment use. Reduce that amount by any credits and deduction allocable to the property. The following are examples of some of the credits and deductions that reduce basis. ¥!Any deduction for Section 179 property ¥!Any deduction for removal of barriers to the disabled and the elderly. ¥!Any special depreciation allowance (i.e., Bonus depreciation) ¥!Basis adjustment for investment credit property under section 50(c) of the Internal Revenue Code.Ó (p. 41). For example, a property that has a recovery period of three years is depreciated over four recovery periods with a half-year in the first and fourth year. To account for behavioral responses by taxpayers attempting to increase their depreciation deduction by making a large percent of their total yearsÕ investment in last three !$-!months of the taxable year, the IRS has more than one applicable convention. If 40 percent of the total basis of depreciable property is placed into service in the last three months of the taxable year, the half-year convention no longer applies, and a mid-quarter convention is used. Mid-quarter convention treats all property placed in service during any month as placed in service on the mid-point of such month (26 U.S. Code ¤ 168, 2015). Table 2.3 provides additional information on deduction amounts per period. Under MACRS, the recovery period is defined as the number of years over which the cost or other basis is recovered (IRS, 2015). All assets that share the same recovery period fall into an asset class.!""!Table 2.3 MACRS GDS Percentage Table Recovery Year 3-Year Class 5-Year Class 7-Year Class 10-Year Class 15-Year Class 20-Year Class (Percent of Depreciable Basis) 1 25 15 10.71 7.5 5.00 3.75 2 37.5 25.5 19.13 13.88 9.50 7.219 3 25 17.85 15.03 11.79 8.55 6.677 4 12.5 16.66 12.25 10.02 7.70 6.177 5 16.66 12.25 8.74 6.93 5.713 6 8.33 12.25 8.74 6.23 5.285 7 12.25 8.74 5.90 4.888 8 6.13 8.74 5.90 4.522 9 8.74 5.91 4.462 10 8.74 5.90 4.461 11 4.37 5.91 4.462 12-15 5.90 4.461 16 2.95 4.462 17-20 4.461 21 2.231 Note: Annual Recovery (Percentage of Original Depreciable Basis), (150% DB is used for farm property placed in service after 1988. Half-year convention)!"#!2.2 Depreciation Examples To better understand the mechanics of MACRS, an example is given in Table 2.4. Calculating MACRS depreciation deduction starts with the basis of the asset placed in service, which is often the purchase price. Because no asset with a remaining basis was traded for this asset, the purchase price serves as the initial basis of the deduction and is annually adjusted to account for potential credits and adjustments. The initial basis is the asset cost multiplied by the percent of business use (IRS Publication 225, FarmerÕs Tax Guide, 2014, p. 41). The depreciable basis is the amount of basis remaining after proper credits and adjustments, such as salvage value, investment credits, and Accelerated depreciation, are made. The depreciable basis is spread over the useful life of an asset as defined by the relevant asset class. In the example, the property placed in service is 10-year property. As assumed, it has a half-year convention. The recovery rate is the percent of the depreciable basis that is taken that period. This amount is captured in the depreciation expense column in the table below. Accumulated depreciation is the cumulative value of depreciation taken. At the end of the final recovery period, this value will equal the depreciable basis of the asset. Similarly, the net book value, calculated as (depreciable basis-accumulated depreciation), of the asset will reach zero in the same period because this column represents the amount of basis remaining. The initial input values for Table 2.4 example include a purchase price of $650,000 and $0 in salvage value. This gives the asset a depreciable basis of $650,000 ($650,000-$0). The estimated life of this asset is ten years, and a half-year convention applies. The net book value calculated is the depreciable basis less the accumulated depreciation. !"$!Table 2.4 Example of MACRS GDS 150% Declining Balance Method Year Recovery Rate Depreciable Basis Depreciation Expense Accumulated MACRS Depreciation Net Book Value % $ 1 7.50 650,000 48,750 48,750 601,250 2 13.88 650,000 90,220 138,970 511,030 3 11.79 650,000 76,635 215,605 434,395 4 10.02 650,000 65,130 280,735 369,265 5 8.74 650,000 56,810 337,545 312,455 6 8.74 650,000 56,810 394,355 255,645 7 8.74 650,000 56,810 451,165 198,835 8 8.74 650,000 56,810 507,975 142,025 9 8.74 650,000 56,810 564,785 85,215 10 8.74 650,000 56,810 621,595 28,405 11 4.37 650,000 28,405 650,000 0 The Economic Recovery Tax Act of 1981 introduced what we recognize today as Section 179 depreciation deduction. When the shift to the MACRS recovery system was introduced in 1986, Sec 179 continued. Internal Revenue Code Section 179 is formally titled the ÒElection to Expense Certain Depreciable Business Assets.Ó Section 179 states that ÒA taxpayer may elect to treat the cost of any Section 179 property as an expense which is not chargeable to capital account. Any cost so treated shall be allowed as a deduction for the taxable year in which the Section 179 property is placed in serviceÓ (26 U.S. Code ¤ 179 - Election to expense certain depreciable business assets, 2015). Section 179 allows farms to deduct the full purchase price of qualifying equipment purchased or financed during the tax year. The taxpayer can deduct the full purchase price of a new business investment from their gross taxable income (IRS, 2015). Section 179 sets a maximum expense deduction and maximum investment limit for the tax year. The maximum expense deduction is the largest value a business can choose to elect as their Section 179 deduction in the current year. The maximum investment limitation dictates !"%!how much a business can spend in the year and still claim a Section 179 deduction. The maximum investment limitation decreases the maximum expense deduction dollar for dollar if total investment in eligible property is over the current investment dollar limit. For example: if a farm purchases $2,500,000 worth of eligible property when the current investment limit is $2,000,000, their Section 179 deduction is reduced to zero: $2,500,000 of purchases - $2,000,000 maximum investment limit = $500,000 of dollar for dollar reduction in Section 179 deduction. $500,000 maximum Section 179 expense - $500,000 dollar for dollar reduction in deduction = $0 eligible for Section 179 deduction. In addition to the Section 179 expensing allowance, taxpayers have the option of claiming an additional first-year, or Bonus, depreciation allowance as stated in section 168(k) of the IRS tax code (Congressional Research Service, 2015). ÒThe Job Creation and Worker Assistance Act of 2002 (P.L. 107-147) created the bonus depreciation allowance. It was equal to 30% of the adjusted basis of new qualified property acquired after September 11, 2001Ó (Congressional Research Service, 2015). The ÒBonusÓ is the ability to deduct immediately a percentage of the cost of the qualifying asset purchased. Bonus depreciation applies only to new MACRS GDS property with a recovery period of 20 years or less that is placed into service for business use in the current year. It may not be taken on used property, assets that require an ADS recovery period, or assets that have a recovery period longer than 20 years. Bonus depreciation may be claimed overall qualifying assets in an asset class after deductions that reduce the depreciable basis have been taken. Bonus depreciation may be taken over multiple asset classes in the current year. The remaining depreciable basis of the asset after Bonus depreciation is taken is placed on a regular MACRS depreciation deduction in the following years. The Bonus depreciation deduction is only limited by the total amount invested in an asset !"&!class. ÒBonus depreciation is useful to very large businesses spending more than the Section 179 spending cap ($2,000,000 in 2015) on new capital equipment. Also, businesses with a net loss are still qualified to deduct some of the cost of new equipment and carry-forward the lossÓ (IRS, 2015). Bonus depreciation may be taken on carryover basis from trade-ins. Carryover basis is the amount of undepreciated basis. Carryover basis plus the basis of the newly acquired property is the amount eligible to be depreciated in the year a newly purchased asset is placed in service. Carryover basis is not eligible for Section 179 depreciation (IRS, 2015). If a business trades in an asset that was purchased new for a new asset, the remaining undepreciated basis from the old asset is included in the amount eligible for Bonus depreciation of the newly purchased asset. For example, if the asset traded in was purchased new and has a depreciable basis of $100,000 left and the new asset replacing it has a depreciable basis of $300,000 the basis amount eligible for Bonus depreciation will be $400,000. Section 179 does not allow filers to create a net farm loss. As with any deduction, the greatest benefit of the deduction is derived by allocating the deduction to the longest recovery period (IRS, 2015). This added allowance accelerated the depreciation of qualified property, lowering the cost of capital for investment in those assets and increasing the cash flow of companies making such investments (Congressional Research Service, 2015). When utilizing Bonus depreciation, the recovery rate percent (or percent of depreciable basis deducted each period) in the first year will naturally increase. Table 2.5 displays Section 179 maximum investment limitations and the maximum expense deductions for tax years 2004 through 2014. !"'!Table 2.5 Section 179 Investment and Expense Deduction Limitations and Bonus Deduction, 2004-2014 Tax Year Maximum Sec 179 Expense Deduction Maximum Sec 179 Investment Limitation Bonus Deduction (% of Total Expense) $ % 2004 102,000 410,000 50 2005 105,000 420,000 0 2006 108,000 430,000 0 2007 125,000 500,000 0 2008 250,000 800,000 50 2009 250,000 800,000 50 2010 500,000 2,000,000 50 2011 500,000 2,000,000 100 2012 500,000 2,000,000 50 2013 500,000 2,000,000 50 2014 500,000 2,000,000 50 When electing deductions to reduce the depreciable basis of property farmers have the option of electing two Accelerated depreciation deductions, any additional investment credits, and a regular yearly MACRS GDS 150% DB depreciation. Section 179 and Bonus depreciation are the available Accelerated depreciation options farmers may elect either or both of these deductions on investments placed in service for the current year. If a farmer elects only one of the Accelerated deductions, that amount is subtracted from the assetÕs current depreciable basis, and MACRS depreciation deductions are calculated from the new adjusted basis. If the taxpayer elects both forms of Accelerated depreciation in the current year, Section 179 must be deducted first followed by Bonus depreciation. The remaining book value after this deduction is then again depreciated via MACRS over the appropriate recovery periods. In Table 2.6 there is an example of Section 179 use, Bonus depreciation use, and joint use of Section 179 and Bonus use. In each example, the remaining depreciable basis is assigned to MACRS depreciation over the remaining recovery periods. For each example, the purchase !"(!price is $650,000 with a salvage value of $0 and the asset has a 10-year recovery period with a half-year convention. We also assume the maximum investment limitation is not exceeded, and 2014 Accelerated depreciation regulations apply. Recovery period 0 represents adjustments to the depreciable basis before the first year MACRS depreciation is taken on the remaining adjusted depreciable basis. The MACRS GDS recovery rate is 150% DB. !"#!!Table 2.6 Example of Section 179, Bonus and Joint Use of Accelerated Depreciation Deduction Recovery Period (Years) MACRS Recovery Rate (%) Section 179 and MACRS Depreciation Deductions Bonus and MACRS Depreciation Deductions Section 179, Bonus and MACRS Depreciation Deductions Depreciable Basis MACRS Depreciation Expense Accumulated Depreciation with Section 179 Accumulated MACRS Depreciation Net Book Value Depreciable Basis MACRS Depreciation Expense Accumulated Depreciation with Bonus Accumulated MACRS Depreciation Net Book Value Depreciable Basis MACRS Depreciation Expense Accumulated Depreciation with Bonus and Section 179 Accumulated MACRS Depreciation Net Book Value $ $ $ 0 - 650,000 0 500,000 0 150,000 650,000 0 325,000 0 325,000 650,000 0 575,000 0 75,000 1 7.5 150,000 11,250 511,250 11,250 138,750 325,000 24,375 349,375 24,375 300,625 75,000 5,625 580,625 5,625 69,375 2 13.88 150,000 20,820 532,070 32,070 117,930 325,000 45,110 394,485 69,485 255,515 75,000 10,410 591,035 16,035 58,965 3 11.79 150,000 17,685 549,755 49,755 100,245 325,000 38,318 432,803 107,803 217,198 75,000 8,843 599,878 24,878 50,123 4 10.02 150,000 15,030 564,785 64,785 85,215 325,000 32,565 465,368 140,368 184,633 75,000 7,515 607,393 32,393 42,608 5 8.74 150,000 13,110 577,895 77,895 72,105 325,000 28,405 493,773 168,773 156,228 75,000 6,555 613,948 38,948 36,053 6 8.74 150,000 13,110 591,005 91,005 58,995 325,000 28,405 522,178 197,178 127,823 75,000 6,555 620,503 45,503 29,498 7 8.74 150,000 13,110 604,115 104,115 45,885 325,000 28,405 550,583 225,583 99,418 75,000 6,555 627,058 52,058 22,943 8 8.74 150,000 13,110 617,225 117,225 32,775 325,000 28,405 578,988 253,988 71,013 75,000 6,555 633,613 58,613 16,388 9 8.74 150,000 13,110 630,335 130,335 19,665 325,000 28,405 607,393 282,393 42,608 75,000 6,555 640,168 65,168 9,833 10 8.74 150,000 13,110 643,445 143,445 6,555 325,000 28,405 635,798 310,798 14,203 75,000 6,555 646,723 71,723 3,278 11 4.37 150,000 6,555 650,000 150,000 0 325,000 14,203 650,000 325,000 0 75,000 3,278 650,000 75,000 0 !!!"#! The first example in Table 2.6 demonstrates the use of Section 179 depreciation with the remaining depreciable basis being depreciated via MACRS. Farmers have the option of selecting any Section 179 dollar amount equal to or lower than their allowable limit. In this exercise, we utilized the maximum allowable Section 179 expense of $500,000. The investment of $650,000 less the Section 179 deduction provides the net book value in period 0, which is used as the depreciable basis for the period 1 MACRS depreciation expense calculation. Use of Section 179 in period 0 plus the MACRS deduction in period 1 is the total first-year depreciation deduction, $511,250. In this example, the first year deduction is approximately 79% of the initial investment. The MACRS depreciation expense is the rate recovery rate times the appropriate adjusted depreciable basis. The MACRS depreciation expense from periods 2 through 11 decreased, thus allowing the farmer to capture more of the non-cash depreciation expense early in the assets life. The accumulated depreciation with Section 179 is the cumulative amount of depreciation taken in that period consisting of Section 179 deduction plus all previous MACRS deductions. Accumulated depreciation with Section 179 will sum to the initial basis at the end of the depreciation period. Similarly, accumulated MACRS depreciation is the cumulative amount of MACRS deduction and will sum to the adjusted depreciable basis initially used in calculated period 1 MACRS deduction in the final depreciation period. The net book value is the depreciable basis less the accumulated MACRS depreciation and will be $0 at the end of the final depreciation period. The third example includes the use of both forms of Accelerated depreciation. When electing both deductions Section 179 must be used first followed by Bonus and then the remaining (if any) adjusted depreciable basis is applied to MACRS. The total first-year !$%!deduction in the last section was $580,625, or approximately 89% of the initial investment. To calculate the first year deduction Section 179 is subtracted from the initial basis first (650,000-500,000=150,000). This is done for two reasons. First, Section 179 ($500,000 in this example) must be taken before Bonus depreciation. Second, by subtracting!the Section 179 deduction, a new adjusted depreciable basis is created that will be used for calculating the Bonus deduction. This newly adjusted basis is then used to calculate the Bonus depreciation deduction. Bonus depreciation in this example is 50% of the depreciable basis (150,000*.50=75,000). These two deductions are then added to create the total first year Accelerated depreciation deduction (500,000+75,000=575,000). After these deductions are taken the adjusted depreciable basis used for MACRS is $75,000. The addition of the first year MACRS deduction (5,625) with Accelerated depreciation deductions (575,000) equals the total first year depreciation deduction of $580,625. As the examples above show, utilizing both forms of Accelerated depreciation can increase the total first-year deduction. In the Section 179 example, the total first-year depreciation was $511,250. Total first-year depreciation when utilizing Bonus was $349,375. When both forms of Accelerated depreciation were employed the total year, one deduction was $580,625. The IRS dictates the order of election when the producer utilizes both forms of Accelerated depreciation. If Section 179 and Bonus are used, Section 179 must be used first followed by Bonus and then MACRS. The IRS dictates this order to minimize the total amount of depreciation claimed in the first year. To illustrate the reasoning behind the order of election Table, 2.7 provides two scenarios of different order elections. !$"!Table 2.7 Order of Accelerated Depreciation Election Purchase price ($) First elected deduction Adjusted depreciable basis ($) Second elected deduction Accelerated first-year deduction($) Scenario 1 650,000 Section 179 -- Bonus -- -- 500,000 150,000 75,000 575,000 Scenario 2 650,000 Bonus -- Section 179 -- -- 325,000 325,000 325,000 650,000 In Table 2.7 Scenario 1 demonstrates Section 179 being utilized first followed by Bonus. In this scenario, the total Accelerated first-year deduction is $575,000. Scenario 2 where Bonus is used first yields a $650,000 Accelerated first-year deduction. In both scenarios, the Section 179 amount elected is the maximum allowed for that situation. Bonus depreciation was taken at 50% of the depreciable basis. This chapter provided a brief history of US tax depreciation, description of asset classes and the mechanics used to calculated depreciation deductions. Multiple examples of MACRS and Accelerated depreciation deductions were provided and explained. The following chapters examine how agricultural producers have used MACRS and Accelerated depreciation in their farm businesses. Chapter 3 provides summary statistics on the data set by farm size and depreciation use and takes a closer look at the details of Bonus depreciations. !$$!Chapter 3. Data and Summary Statistics The panel data set used in this research includes 66 farm operations and from 2004 through 2014. Sixty-five of the 66 farms had 11 years of complete tax and financial information. The remaining farm is missing farm income and expense information for 2014. Of the 66 farms, 29 are dairy, and 31 are crop farms. The remaining six are categorized as diversified and include beef (1), custom heifer raiser (1), hog (3) and vegetable (1) enterprises. All producers in the data utilized the common MACRS depreciation method as allowed by IRS. 3.1 Farm Size To examine the size of the farms in the dataset gross farm income (GFI), Schedule F net farm profit or loss, and acres operated were used. Gross farm income is defined as all farm-related income the operation generated in a given year. It includes income from milk and crop sales, rental income, government payments, insurance income, and any other farm income. Schedule F net farm profit or loss is calculated from the farms GFI less tax depreciation and total cash expenses. Tax depreciation includes all forms of depreciation taken on Schedule F, including deductions from Accelerated and MACRS. Acres operated includes all land, rented and owned, that was used in production. GFI is broken down by farm type in table 3.1 and is grouped by size in table 3.2. Table 3.1 Gross Farm Income by Farm-Type, 2004-2014 Variable Observations Mean Std. Dev. Min Max $ All Farms 653 1,357,355 1,669,207 24,388 15,900,000 Crop Farms 308 776,525 659,729 24,388 3,037,790 Dairy Farms 285 1,894,807 2,234,477 28,338 15,900,000 Diversified Farms 60 1,786,059 1,071,822 463,187 4,571,987 !$&!The largest GFI of $15,900,000 was from a dairy farm, and the smallest GFI of $24,388 was a crop farm. The number of observations between these two types of farms was similar while the standard deviation and maximum values were not. These large differences make it difficult to compare GFI across farm type. The most common farm size by GFI was one to three million dollars. Table 3.2 Frequency of Gross Farm Income Gross Farm Income Range ($) Frequency Percent 0-500,000 184 28.2 500,001-1,000,000 188 28.8 1,000,001-3,000,000 222 34.0 3,000,001-8,000,000 50 7.7 8,000,001+ 9 1.4 !"#!Table 3.3 Gross Farm Income by Farm-Type and Year Crop Farms Dairy Farms Diversified Farms Obs Mean Std. Min Max Obs Mean Std. Min Max Obs Mean Std. Min Max $ $ $ 2004 27 552,476 496,795 24,388 2,145,914 24 1,238,667 1,522,960 193,733 7,243,896 6 1,594,197 1,188,930 463,187 3,506,824 2005 25 611,543 513,393 30,322 2,158,749 23 1,288,743 1,629,060 199,478 7,487,369 5 1,513,307 1,232,277 581,935 3,506,824 2006 25 601,766 521,676 46,724 2,067,119 25 1,247,307 1,396,082 192,967 6,608,370 5 1,417,738 1,136,032 518,153 3,285,926 2007 26 690,819 608,100 47,915 2,751,202 25 1,748,560 1,974,593 219,806 8,367,034 5 1,554,827 1,055,878 573,460 3,249,422 2008 29 771,193 651,470 109,178 2,910,991 27 2,279,050 3,265,460 96,856 15,900,000 6 1,852,748 1,162,531 653,988 3,939,854 2009 30 776,518 654,548 75,520 2,586,944 28 1,421,450 1,526,964 59,236 7,345,444 6 1,752,287 1,263,043 618,655 4,139,534 2010 29 684,482 545,338 51,550 2,167,388 28 1,753,363 1,823,406 54,500 8,112,246 6 1,989,161 1,260,503 688,065 4,167,769 2011 29 933,378 683,336 95,263 2,290,591 27 2,236,931 2,262,030 58,116 9,922,914 6 2,221,066 1,412,599 777,020 4,571,987 2012 29 1,001,146 809,327 93,248 2,983,883 27 2,222,137 2,436,257 28,338 11,000,000 5 1,768,332 809,803 855,809 2,704,246 2013 29 954,687 784,173 129,290 2,924,097 26 2,423,102 2,542,457 77,484 11,000,000 5 1,912,445 922,885 839,996 3,074,479 2014 30 888,718 768,365 129,199 3,037,790 25 2,877,180 2,950,402 102,625 12,500,000 5 1,974,703 882,637 931,026 3,101,936 Total 308 285 60 !"#! Table 3.3 breaks down mean GFI by farm type and year revealing a trend of increasing GFI for all three farm types from 2004 to 2014. The high grain prices in 2011, 2012 and 2013 resulted in higher crop farm GFI compared to early years. Dairy GFI painted a similar picture except in 2009 when there were low milk prices. The profit a farm report to the IRS is generated from their Form 1040 Schedule F ÒProfit or Loss from Farming.Ó The Schedule F net farm profit or loss was calculated as reported farm gross income fewer farm expenses. Table 3.4 summarizes average Schedule F net farm profit or loss by farm type. Dairy farms had a larger average Schedule F Profit and larger standard deviation than the other farm types. Crop farms and diversified farms had similar Schedule F average profits. The bulk of farm Schedule F profits, 40%, fell in the $100,001 to $500,000 Schedule F net farm profit range. The range below that, from $1-$100,000 had 258 observations, 40% of the total. These two Schedule F ranges hold the majority farms represented in the data, and this is clearly depicted in table 3.5. Table 3.4 Schedule F, Net Farm Profit or Loss by Farm-Type Variable Observations Mean Std. Dev. Min Max $ All Farms 652 207,017 669,198 -1,257,156 14,400,000 Crop Farms 307 118,398 182,125 -1,257,156 849,347 Dairy Farms 285 320,188 981,773 -1,180,411 14,400,000 Diversified Farms 60 122,886 140,103 -539,663 454,668 Table 3.5 Frequency of Schedule F, Net Farm Profit or Loss Net Profit or Loss Range ($) Frequency Percent 0 and Less 83 12.7 1-100,000 258 39.6 100,001-500,000 262 40.2 500,001-1,000,000 25 3.8 1,000,001+ 24 3.7 !"#! Table 3.6 Schedule F, Net Farm Profit or Loss by Farm-Type and Year Crop Farms Dairy Farms Diversified Farms Obs Mean Std. Min Max Obs Mean Std. Min Max Obs Mean Std. Min Max $ $ $ 2004 27 66,580 123,895 -94,260 506,446 24 197,442 334,421 -40,260 1,550,011 6 134,433 73,434 56,258 252,570 2005 25 80,561 119,882 -44,708 453,120 23 236,802 522,003 -60,525 2,254,163 5 154,287 108,722 67,680 335,360 2006 25 37,624 71,494 -136,359 216,134 25 157,799 311,426 -77,862 1,488,660 5 132,295 119,798 21,733 300,853 2007 26 58,247 140,300 -415,658 346,149 25 259,888 356,592 -78,816 1,558,517 5 146,133 108,426 44,971 312,586 2008 29 30,375 271,908 -1,257,156 435,920 27 785,837 2,759,626 -89,655 14,400,000 6 120,980 190,868 -180,455 389,258 2009 30 139,586 126,384 4,886 489,378 28 51,213 239,970 -284,395 1,128,971 6 35,956 298,995 -539,663 268,606 2010 29 118,031 155,890 -185,740 525,677 28 192,168 360,325 -85,418 1,310,030 6 156,204 166,364 -6,041 454,668 2011 29 187,957 144,921 -17,786 621,205 27 336,917 530,073 -130,674 2,406,676 6 155,515 115,870 18,205 357,052 2012 29 235,917 219,502 -136,179 838,705 27 389,596 640,309 -91,779 2,309,050 5 106,369 43,271 62,181 164,482 2013 29 192,107 235,346 -98,291 849,347 26 338,408 756,034 -1,180,411 2,819,933 5 93,185 87,394 10,574 209,952 2014 30 128,968 166,355 -50,796 763,215 25 567,180 741,441 28,155 3,253,441 5 118,659 91,626 -20,855 219,457 Total 307 285 60 !"#!Table 3.6 displays a similar trend for Schedule F net farm profit or loss as table 3.3 does when looking at GFI. Schedule F net farm profit or loss increased over the years with higher profits being realized in high GFI years. The low prices of 2009 in the dairy industry are again depicted with a low Schedule F mean value. To further investigate the size of farming operations the production resource of land is evaluated. The number of acres operated includes rented and owned land. Table 3.7 shows the average number of acres operated by farm type. The average number of acres was close to 1,000 across all categories. The small minimum farm size of 60 acres shows there may be some crop farmers in that data that did not farm full time. However, it was not the norm in this data. The largest number of farms fall between the range of 501 to 1,000 acres. Table 3.7 Acres Operated by Farm-Type Variable Observations Mean Std. Dev. Min Max Acres All Farms 706 1,042 803 60 4,664 Crop Farms 337 1,118 886 60 4,664 Dairy Farms 312 931 761 115 4,337 Diversified Farms 57 1,197 254 388 1,638 Table 3.8 Frequency of Acres Operated Bin Value ($) Frequency Percent 0-250 50 7 251-500 132 19 501-1,000 263 37 1,001-1,500 128 18 1,501+ 133 19 !"#!Table 3.9 Acres Operated by Farm-Type and Year Crop Farms Dairy Farms Diversified Farms Obs Mean Std. Min Max Obs Mean Std. Min Max Obs Mean Std. Min Max Acres Acres Acres 2004 30 1,069 843 102 3,497 28 877 773 179 3,960 5 1,074 223 726 1,263 2005 30 1,112 990 96 4,664 28 884 762 179 3,831 5 1,153 237 773 1,396 2006 30 1,142 958 95 3,943 28 897 762 256 3,831 5 1,179 299 704 1,441 2007 30 1,123 934 156 3,625 28 888 750 214 3,831 5 1,182 246 823 1,505 2008 31 1,113 913 156 3,596 28 924 820 293 4,275 5 1,249 243 853 1,460 2009 31 1,095 878 156 3,473 29 961 812 215 4,337 5 1,165 181 854 1,302 2010 31 1,091 879 60 3,410 29 874 661 140 3,573 5 1,227 199 904 1,379 2011 31 1,115 861 151 3,410 29 941 732 199 3,573 5 1,317 133 1,193 1,513 2012 31 1,123 822 151 3,246 29 983 761 200 3,858 5 1,229 225 1,004 1,541 2013 31 1,184 947 151 3,606 29 1,007 791 125 3,998 6 1,162 444 388 1,638 2014 31 1,133 855 151 3,246 27 1,004 853 115 4,304 6 1,226 348 773 1,638 Total 337 312 57 !"#! Table 3.9 shows crop farms were on average, 193 acres larger than dairy farms and all types of operations grew over the years. On average crop farms and diversified farms operated a similar amount of acres. Pairwise correlation coefficients of GFI, acres operated and Schedule F net farm profit or loss is examined in Table 3.10. GFI had the strongest correlation to acres operated and Schedule F net farm profit or loss. Table 3.10 Pairwise Correlation of Size Variables GFI Acres operated GFI 1.00 -- Acres operated 0.59 1.00 Schedule F Net Farm Profit or Loss 0.71 0.27 3.2 Income Tax Depreciation Table 3.11 shows the summary stats for Section 179 expense taken, Bonus depreciation deduction and first year MACRS depreciation taken. The maximum expense possible to elect over the 11-year period for Section 179 was $500,000. This amount was eligible as the maximum deduction in the later years of the data. It is important to note the large value of maximum Bonus depreciation taken. Bonus depreciation can be used on the carryover basis of like-kind exchanges. The remaining carryover basis for the year of replacement and the remaining excess basis, if any, for the year of a replacement for the acquired MACRS property are eligible for the additional first-year depreciation deduction. The applicable percentage of additional first-year depreciation deduction applies to the remaining carryover basis and remaining the excess basis of the acquired MACRS property (IRS, 2014). !$%!Table 3.11 Depreciation Summary Statistics Not Conditional on Accelerated Depreciation Use Variable Observations Mean Std. Dev. Min Max $ Section 179 Expense 726 21,951 54,180 0 500,000 Bonus 726 4,970 41,270 0 688,892 First Year MACRS 726 5,838 10,357 0 85,402 Table 3.12 Summary Statistics of Section 179 Use Conditional on Election of Section 179 Depreciation Deduction Variable Observations Mean Std. Dev. Min Max $ All Farms 305 52,250 73,570 101 500,000 Crop Farms 175 50,968 79,182 101 500,000 Dairy Farms 92 45,142 47,654 765 212,010 Diversified Farms 38 75,360 93,372 236 361,847 Table 3.12 shows that when Section 179 depreciation deduction is used the average deduction is close to $50,000 for crop and dairy farms. Diversified farms had the highest average Section 179 depreciation deduction with $75,360. As expected, these conditional mean values are larger than the unconditional mean for Section 179 depreciation as shown in table 3.11. The maximum Section 179 expense over the available years varied by year but was as high as $500,000. !"#!Table 3.13 Frequency and Average Amount of Section 179 Depreciation Deduction Taken by Year and Farm-Type, Conditional on Section 179 Use Year Max Expense ($) All Farms Crop Farms Dairy Farms Diversified Frequency Ave Deduction ($) Frequency Ave Deduction ($) Frequency Ave Deduction ($) Frequency Ave Deduction ($) 2004 102,000 26 22,670 12 16,492 10 25,213 4 34,843 2005 105,000 30 29,766 12 23,738 13 31,677 5 39,263 2006 108,000 21 20,702 12 15,837 6 18,453 3 44,662 2007 125,000 29 29,479 13 22,216 13 28,056 3 67,125 2008 250,000 28 46,612 16 33,368 9 58,104 3 82,772 2009 250,000 17 47,360 13 42,797 2 54,079 2 70,303 2010 500,000 26 39,274 17 41,191 6 33,320 3 40,320 2011 500,000 32 73,486 21 73,252 8 61,811 3 106,256 2012 500,000 34 58,117 21 65,241 8 51,794 5 38,314 2013 500,000 32 92,354 20 90,268 8 62,575 4 162,341 2014 500,000 30 91,665 18 80,757 9 85,918 3 174,352 Total/Average 305 52,250 175 50,968 92 45,142 38 75,360 !"#!Table 3.13 provides a breakdown of the deduction by farm type and year. It is important to note the maximum allowable Section 179 expense per year. When looking across all farms, the frequency of deductions taken was fairly consistent with the exception of 2009. In 2009, the total deductions were lower because of decreased frequency of Section 179 use by dairy farms. From 2008 to 2009 dairy farms had an average decrease in GFI of 62%. With a decrease in taxable income, the need for tax deductions decreased. Over the 11-year period, the total average deduction increased with average GFI. Crop farms use of Section 179 increased 2011 to 2013 because of increase in income over the same period. During the same three-year period, the average deduction is taken also increased. Table 3.14 Section 179 Use by Asset Class Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Total All 23 135 267 53 75 0 553 Crops 16 70 155 9 55 0 305 Dairy 4 40 80 30 9 0 163 Diversified 3 25 32 14 11 0 85 !""!Table 3.15 Section 179 Use by Asset Class, Farm-Type and Year Crop Farms Dairy Farms Diversified Farms Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Total Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Total Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Total Grand Total Farm 2004 1 3 10 1 2 0 17 0 4 8 3 0 0 15 0 1 4 1 0 0 6 38 2005 1 6 10 1 4 0 22 0 7 13 4 2 0 26 0 2 2 3 1 0 8 56 2006 3 3 12 1 4 0 23 0 3 4 2 0 0 9 1 2 2 0 1 0 6 38 2007 2 5 11 0 4 0 22 0 5 13 2 1 0 21 0 1 3 1 0 0 5 48 2008 0 4 14 0 4 0 22 2 5 8 2 2 0 19 1 3 3 2 1 0 10 51 2009 0 11 6 0 4 0 21 0 0 1 2 0 0 3 0 1 1 0 1 0 3 27 2010 1 5 16 0 6 0 28 0 2 5 2 1 0 10 0 3 3 1 0 0 7 45 2011 3 9 19 2 5 0 38 0 4 6 5 0 0 15 0 1 3 2 2 0 8 61 2012 2 6 21 1 11 0 41 0 1 7 1 1 0 10 0 4 5 2 3 0 14 65 2013 2 11 19 1 5 0 38 1 4 7 3 1 0 16 1 4 3 1 1 0 10 64 2014 1 7 17 2 6 0 33 1 5 8 4 1 0 19 0 3 3 1 1 0 8 60 Total 16 70 155 9 55 0 305 4 40 80 30 9 0 163 3 25 32 14 11 0 85 553 !"#! Table 3.15 provides the frequency of deductions by asset class and farm type. Crop farms had the highest number of deductions and asset class 7, which includes machinery and equipment, was the most frequently used class. No deductions were taken for class 20 property as there were no assets purchased that had a 20-year depreciation schedule and were eligible for direct expensing. Table 3.15 shows a distinct increase in the frequency of Section 179 depreciation deduction taken by crop farms across all classes and specifically in class 7 in years 2011-2013. Asset class 15 also saw an increase in elections in 2012 by crop farmers. The most notable point of interest for dairy farm elections is the frequency in 2009 of 3, again linked to a decrease in GFI that year. Class 7 holds the highest number of elections across all farm types. Tables 3.16 and 3.17 breakdown investment frequency and dollar amounts by class across all farms. These tables provide the backdrop to the decisions influencing elections made in table 3.15. Table 3.16 Frequency of Farm Investment, Eligibility for Section 179 Direct Expensing and Section 179 Depreciation Deduction Taken by Asset Class. Investment per asset class Amount eligible for Section 179 direct expensing Section 179 depreciation deduction taken Asset Class Frequency Percent Frequency Percenta of Eligible Frequency Percentb of Eligible Percentc Taken 3 87 5 87 100 23 26 26 5 461 26 460 100 135 29 29 7 632 35 631 100 267 42 42 10 191 11 190 99 53 28 28 15 205 12 180 88 75 42 37 20 43 2 0 0 0 0 0 27.5 25 1 0 0 0 0 0 Non-Dep Property 137 8 0 0 0 0 0 Total 1,781 1,556 553 Percenta=Frequency of eligible Section 179 depreciation deductions/frequency of investment in that class Percentb=Frequency of Section 179 depreciation deductions taken/frequency of investments eligible for Section 179 depreciation Percentc=Frequency of deductions taken/frequency of investment !"$!The last two columns in Table 3.16 show the percent of deductions that were taken when the investment was eligible for the deduction and the percent of deductions that were taken from all investments in that asset class. These two metrics are the same with the exception of class 15 property. 42% of the time a deduction was taken when it was eligible and 37% of the time a deduction was taken when investment in that asset class was made. These two columns show the consistency with which Section 179 was utilized when available. With the majority of investment in asset classes 3 through 15 being eligible for Section 179 direct expensing, the percent of deductions taken on eligible property and percent of the deduction taken on invested property were similar. When an investment was made in class 3 property, 26% of the time producers elected to direct expense all or part of it. For class 5 assets, 29% of the time farmers took a Section 179 direct expense. Class 7 had the highest percent frequency of Section 179 depreciation deduction with 42% of farmers taking at least some direct expensing. This particularly noteworthy when looking at how relatively large the total percent of investment was in class 7 property with 35% of all investment. Table 3.17 Average of Investment, Amount Eligible for Section 179 Direct Expensing and Section 179 Depreciation Deduction Taken by Asset Class Asset Class Average farm investment Average Amount eligible for Section 179 direct expensing Average Section 179 depreciation deduction taken ($/Year) 3 24,413 24,738 28,351 5 47,388 45,404 28,351 7 121,225 119,831 73,970 10 114,431 112,657 55,476 15 30,400 28,663 21,747 20 50,742 0 0 27.5 81,102 0 0 Non-Depreciable Property 234,569 0 0 !"%! Table 3.17 provides average values to the frequencies used in table 3.16. The last column of average Section 179 depreciation deductions taken provides insight into how much farmers were deducting on average from the purchase price of their assets placed in service. The largest average value of depreciation deduction was for class 7 property at $73,970. As expected the average deduction were larger in longer-lived asset classes. Asset classes 7 and 10 had the highest average depreciation deduction taken. These classes had the highest average total farm investment made in them, so a corresponding Section 179 depreciation deduction was expected. Bonus depreciation is the second type of Accelerated depreciation available to farmers. It can be claimed on only new property placed into service, and the depreciation deduction is set at a percent of total depreciable basis, usually equal to the purchase price. Unlike Section 179 depreciation deductions, when claiming a Bonus depreciation deduction, the farmer must claim the entire value of the deduction, and it must be taken over all eligible property that shares the same asset class. In this dataset, there was a total of 47 Bonus depreciation deduction taken across all operations for the 11l year period. Table 3.18 shows the summary stats of Bonus depreciation deductions conditional on Bonus depreciation use. Dairy farms had the largest average Bonus depreciation deduction at $179,748. The number of observations for Bonus depreciation deductions was fewer than that of Section 179. The average value of Bonus depreciation deductions is higher across all farm types ($100,886 versus $52,250) than Section 179 depreciation deductions. This higher average Bonus deduction was driven by the high deductions taken by dairy farmers ($179,748 average Bonus versus $45,142 average Section 179 depreciation deduction). !"&!Table 3.18 Summary Statistics of Bonus Depreciation Conditional on Elected Bonus Depreciation Deduction Variable Observations Mean Std. Dev. Min Max $ Bonus Expense Taken 70 100,886 203,402 476 1,377,784 Crop 33 41,279 64,002 476 345,318 Dairy 29 179,748 292,504 2,470 1,377,784 Diversified 8 60,894 50,102 2,715 144,273 To better understand Bonus depreciation use across farm types per year, table 3.19 displays frequency of deductions and average amounts. !"#!Table 3.19 Frequency and Average Amount of Bonus Depreciation Deduction by Year and Farm-Type Year Bonus(%) All Farms Crop Farms Dairy Farms Diversified Frequency Ave Deduction ($) Frequency Ave Deduction ($) Frequency Ave Deduction ($) Frequency Ave Deduction ($) 2004 50 17 95,861 5 30,465 9 144,701 3 58,331 2005 0 0 0 0 0 0 0 0 0 2006 0 0 0 0 0 0 0 0 0 2007 0 0 0 0 0 0 0 0 0 2008 50 4 222,067 2 8,865 2 869 0 0 2009 50 1 10,086 1 10,086 0 0 0 0 2010 50 8 34,451 3 6,823 4 43,975 1 79,238 2011 100 13 196,216 10 67,045 3 626,786 0 0 2012 50 12 70,052 8 47,108 3 153,683 1 2,715 2013 50 7 56,870 2 25,552 2 58,390 3 76,735 2014 50 8 58,618 2 31,592 6 67,626 0 0 Total/Average 70 100,886 33 41,279 29 179,748 8 60,894 !"#! The Bonus depreciation percent each year is the percent of depreciable basis that can be claimed as a deduction. In 2005-2007, there was no Bonus depreciation available. Across all farms, the frequency of Bonus deduction uses increased with the percent of Bonus depreciation. Additionally, the average deduction amount increased in those years. Average dairy farm Bonus depreciation was the highest in six of the eight years Bonus depreciation was available. This is not surprising given their higher gross farm income as well. In 2009 there were no Bonus depreciation deductions claimed for dairy farms in the data. A reflection of their decreased GFI. The average Bonus depreciation deduction for dairy farms over this period was $179,748 with diversified farm Bonus depreciation deductions coming in a distant second with an average value of $60,894. Tables 3.20 and 3.21 breakdown investment frequency and by class across all farm types and years. These tables provide context to the decisions influencing the elections made in table 3.19. Table 3.20 Frequency of Bonus Use by Asset Class, 2004-2014 Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Total Observations All Farms 2 12 23 7 6 20 70 Crop Farms 0 4 10 2 4 13 33 Dairy Farms 1 7 11 5 1 4 29 Diversified Farms 1 1 2 0 1 3 8 !"#! Table 3.21 Bonus Use by Asset Class by Farm-Type and Year Crop Farms Dairy Farms Diversified Farms Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Total Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Total Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Total Cum Total Observations 2004 0 1 1 1 0 2 5 0 3 3 1 0 2 9 0 1 1 0 0 1 3 17 2005 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2006 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2007 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2008 0 1 0 0 0 1 2 0 1 1 0 0 0 2 0 0 0 0 0 0 0 4 2009 0 0 0 0 0 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 2010 0 0 1 0 0 2 3 0 0 2 1 0 1 4 0 0 0 0 0 1 1 8 2011 0 2 2 0 3 3 10 0 0 1 2 0 0 3 0 0 0 0 0 0 0 13 2012 0 0 4 1 1 2 8 0 1 1 0 0 1 3 1 0 0 0 0 0 1 12 2013 0 0 1 0 0 1 2 0 1 1 0 0 0 2 0 0 1 0 1 1 3 7 2014 0 0 1 0 0 1 2 1 1 2 1 1 0 6 0 0 0 0 0 0 0 8 Total 0 4 10 2 4 13 33 1 7 11 5 1 4 29 1 1 2 0 1 3 8 70 !"#! Table 3.21 shows the most frequently selected asset class for Bonus Depreciation is class 7 property. The frequency of Bonus depreciation deductions trends with the frequency of investment by class except 20-year property. As previously discussed, class 20 investments were not eligible for direct expensing under the Section 179 IRS tax rules. This asset class is eligible for expensing only via Bonus depreciation. Producers taking advantage of this policy distinction were frequently electing Bonus depreciation on 20-year property. This is especially true for crop farms. It is possible to crop farms have a greater demand for non-single use agricultural structures that would qualify for Bonus depreciation where animal agriculture has a greater demand for single-use agricultural structures that qualify for Section 179 depreciation deductions. Table 3.21 shows a distinct increase in Bonus depreciation deductions being made by crop farmers in the correspondingly high GFI years of 2011 and 2012. Most crop farmers elected to use their Bonus deductions on class twenty and seven-year property in those years. Dairy farmers utilized Bonus depreciation most often on seven year property. Table 3.22 Frequency of Bonus Depreciation Taken as a Percent of Investment Investment per asset class Bonus depreciation deduction frequency Asset Class Frequency Percent Frequency Percenta 3 87 5 2 2 5 461 26 12 3 7 632 35 23 4 10 191 11 7 4 15 205 12 6 3 20 43 2 20 47 27.5 25 1 -- -- Non-Depreciable Property 137 8 -- -- Total 1,781 70 4% Percenta=Frequency of Bonus depreciation deduction taken/frequency of investment Table 3.22 breaks down how frequently Bonus depreciation deductions were used in each asset class. Class 7 was the most frequent class used to take a Bonus depreciation deduction, as !"$!it is the most invested in class. The number that stands out the most is the 20 occurrences of Bonus depreciation taken on the 20-year property (farm buildings, non-single use). When looking at the percent of Bonus depreciation deductions taken given investment, 47% of the time a deduction as taken on class 20 assets when an investment was made. On average, Bonus depreciation deductions were taken on 4% of eligible investment decisions. Table 3.23 Average Investment and Bonus Depreciation Deduction Taken by Class Asset Class Average farm investment Bonus depreciation deduction $ 3 24,413 38,775 5 47,388 86,189 7 121,225 186,833 10 114,431 93,659 15 30,400 14,830 20 50,742 45,424 27.5 81,102 -- Non-Depreciable Property 234,569 -- Table 3.23 provides the average Bonus depreciation deduction taken with class seven property having the highest average deduction taken at $186,833. These Bonus depreciation deductions were conditional on use of the deduction. The mean depreciation values show that because of the mandatory percentage requirement of Bonus depreciation deductions when an election was made, the average amount of depreciation is relatively high. 3.3 Bonus Depreciation Carryover Basis As previously mentioned, Bonus depreciation allows the farmer to utilize carryover basis. To examine this scenario further, the following example and definitions are taken from the IRS from section 1.168(k)(f)(5)(ii)(B)(G)(H)(I): ¥!!"#$%&'()*+,-+.'/,01'2&-.03+$,'/)-2)*+45678+9-,9)-23+!"%!o!"#$%&'()*+9-,9)-23+:+45678+9-,9)-23+2%&2+.;+2-&';<)--)*+=3+2%)+2 &3)-+&'()(*!+,-./+o!>'/,01'2&-.03+6,'/)-2)*+?+45678+9-,9)-23+2%&2+.;+&$@1.-)*+.'+$,'')$2.,'+A.2%+&'+.'/,01'2&-3+$,'/)-;.,'+,<+,2%)-+45678+9-,9)-23+&'()(*!0!1)2-03)4)56!'+!271380+).!096)1!68)!,1':'50-!'+!.)+61,;).!'5!0!9'1)/+¥!B.C)+,<+*.;9,;.2.,'+o!D%)'+2%)+*.;9,;.2.,'+,<+2%)+)#$%&'()*+,-+.'/,01'2&-.03+$,'/)-2)*+45678E+9-,9)-23+2&F);+90&$)G+¥!6&--3,/)-+=&;.;E+.;+2%)+0);;)-+,!Chapter 4. Analyzing the Farm Effects of Accelerated Depreciation This chapter analyzes the effects of Accelerated depreciation use by Michigan farms. To accomplish this, the present value of the Accelerated tax depreciation as it was used by the farms is calculated in the next section. Following that, the cost of capital is calculated for both MACRS and Accelerated depreciation methods as utilized. The results indicate the value of Accelerated depreciation both in absolute dollar terms and its effect on the cost of capital. 4.1 Value of Depreciation Allowances Present value (PV) is the current value of a future sum of money discounted to the current period (Hanson, Robison, and Black, 2016). A single year PV is calculated by: !"#$%&'()*+,-. Where Value is the future amount of money to be discounted, represented by the current year total depreciation deduction. The discount rate is r and n is the number of time periods. The total PV for each decision is the sum PV of each period. !"#$%&'(.)*+,%/(-..012 !"#! Table 4.1 Example of Section 179, Bonus and Joint Use of Accelerated Depreciation Deduction Recovery Period (Years) MACRS GDS Recovery Rate (%) Section 179 and MACRS Depreciation Deductions Bonus and MACRS Depreciation Deductions Section 179, Bonus and MACRS Depreciation Deductions Depreciable Basis MACRS Depreciation Expense Accumulated Depreciation with Section 179 Accumulated MACRS Depreciation Net Book Value Depreciable Basis MACRS Depreciation Expense Accumulated Depreciation with Bonus Accumulated MACRS Depreciation Net Book Value Depreciable Basis MACRS Depreciation Expense Accumulated Depreciation with Bonus and Section 179 Accumulated MACRS Depreciation Net Book Value $ $ $ 0 - 650,000 0 500,000 0 150,000 650,000 0 325,000 0 325,000 650,000 0 575,000 0 75,000 1 7.5 150,000 11,250 511,250 11,250 138,750 325,000 24,375 349,375 24,375 300,625 75,000 5,625 580,625 5,625 69,375 2 13.88 150,000 20,820 532,070 32,070 117,930 325,000 45,110 394,485 69,485 255,515 75,000 10,410 591,035 16,035 58,965 3 11.79 150,000 17,685 549,755 49,755 100,245 325,000 38,318 432,803 107,803 217,198 75,000 8,843 599,878 24,878 50,123 4 10.02 150,000 15,030 564,785 64,785 85,215 325,000 32,565 465,368 140,368 184,633 75,000 7,515 607,393 32,393 42,608 5 8.74 150,000 13,110 577,895 77,895 72,105 325,000 28,405 493,773 168,773 156,228 75,000 6,555 613,948 38,948 36,053 6 8.74 150,000 13,110 591,005 91,005 58,995 325,000 28,405 522,178 197,178 127,823 75,000 6,555 620,503 45,503 29,498 7 8.74 150,000 13,110 604,115 104,115 45,885 325,000 28,405 550,583 225,583 99,418 75,000 6,555 627,058 52,058 22,943 8 8.74 150,000 13,110 617,225 117,225 32,775 325,000 28,405 578,988 253,988 71,013 75,000 6,555 633,613 58,613 16,388 9 8.74 150,000 13,110 630,335 130,335 19,665 325,000 28,405 607,393 282,393 42,608 75,000 6,555 640,168 65,168 9,833 10 8.74 150,000 13,110 643,445 143,445 6,555 325,000 28,405 635,798 310,798 14,203 75,000 6,555 646,723 71,723 3,278 11 4.37 150,000 6,555 650,000 150,000 0 325,000 14,203 650,000 325,000 0 75,000 3,278 650,000 75,000 0 Total PV($) 608,768 560,665 629,384 !"#! The example above in Table 4.1 shows three examples of Accelerated depreciation use. At the bottom of Table 4.1, the PV amount of the entire depreciation deduction, including MACRS, is calculated. The first example had a total depreciation deduction PV of $608,768. The PV of MACRS depreciation deductions over the same period with no Accelerated depreciation is $471,329. The use of Section 179 deduction in the first year generated a PV increase of $137,439 for the producer. The actual tax savings for the producer would be this value multiplied by the tax rate. In the second example of Table 4.1, Bonus depreciation was used as the method of Accelerated depreciation with the adjusted depreciable basis being applied to an MACRS depreciation schedule. When utilizing Bonus depreciation, the farmer must elect the full amount of the Bonus deduction across all qualifying assets in that asset class. Farmers are not allowed to elect Bonus depreciation on individual items if other qualifying assets share the same asset class. The Bonus depreciation deduction was assumed to be 50% of the investment ($650,000*0.50=$325,000). The depreciable basis is then $325,000. The total first-year depreciation deduction was $349,375, approximately 54% of the initial investment. By incorporating all periodsÕ depreciation expenses, a PV of $560,665 was calculated assuming an 8% discount rate. This is $425,232 larger than the PV of MACRS only. This chapter examines Accelerated depreciation election and the PV of deductions. The PV of Accelerated depreciation deductions is calculated by subtracting the PV of a deduction with no Accelerated depreciation use from the PV of Accelerated depreciation. This value is then multiplied by the appropriate historical tax rate to find the after-tax PV of the depreciation deduction. Tax rates assume the !$%!farmer is filing as a married taxpayer filing jointly. The farms calculated Schedule F net farm profit or loss is used to determine the appropriate tax bracket. Table 4.2 Summary Statistics of Accelerated Depreciation After-Tax Present Values Asset Class Section 179 Bonus Both Deductions Total Accelerated Depreciation Mean ATPV of Accelerated Depreciation Standard Deviation Min Max Observations $ 3 23 2 1 24 727 978 24 3,824 5 135 12 3 144 1,071 2,269 1 18,212 7 267 23 11 279 4,702 9,766 9 98,032 10 53 7 1 59 4,125 8,946 7 54,426 15 75 6 1 80 2,009 2,086 3 12,473 20 0 20 0 20 6,997 11,665 290 51,651 Total 553 70 17 606 - - - - Table 4.2 shows the after-tax present value (ATPV) frequency and summary statistics of Section 179 and Bonus depreciation deductions taken, conditional on the use of either form of Accelerated depreciation. ATPV is defined as the present value of the Accelerated depreciation less the present value of the same investments under MACRS depreciation multiplied by the applicable tax rate. The largest depreciation deduction ATPV of $54,426 was due to the use of a Bonus depreciation deduction in a year with a negative Schedule F net farm profit or loss. Bonus depreciation may be used in years with negative Schedule F profit or loss while that option is not available for Section 179 depreciation deductions. The minimum values in Table 4.2 represent Accelerated depreciation deductions elected. The high maximum values and low minimum values are driven by unique users of Accelerated depreciation and warrant further investigation of Accelerated depreciation use by type, asset class and farm type. !$&!4.2 Section 179 Present Values To find the first year benefit individual producers received from the deductions they took, the present value of their depreciation deductions was multiplied by their tax rate. This after tax present value is calculated for Section 179 and Bonus depreciation deductions. The section below looks at these values by farm type, year, and asset class. Table 4.3 After Tax Present Value Summary Statistics of Section 179 Depreciation Deduction Asset Class Observations Mean ATPV Standard Deviation Min Max $ 3 23 757 988 36 3,824 5 135 826 1,352 1 8,617 7 267 4,058 7,202 9 54,710 10 53 4,159 9,342 7 54,426 15 75 2,020 2,132 3 12,473 20 0 - - - - Total 553 The mean ATPVs for each asset class trends with the total investment and frequency of investment statistics. Class 7, which applies to machinery and equipment, was the most common property to which Section 179 was applied. Class 10, which includes single purpose agricultural structures, had the highest mean ATPV. Class 20 property had no observations; this does not come as a surprise as the 20-year agricultural property is non-single purpose farm buildings (e.g., farm shops). To qualify for Section 179 direct expensing a facility must be a single purpose agricultural (livestock) or horticultural structure (IRS, 2014). These single purpose structures are categorized by the IRS as 10-year property. The minimum ATPV for class 5 and 15 properties, accurately represent Section 179 deductions taken off $60 and $30 respectively. When electing a Section 179 depreciation deduction the farmer has the option of choosing any dollar value up to the total depreciable basis, !$'!barring any adjustments and limitations. To better understand the utilization of Section 179 direct expensing, tables 4.4 and 4.5 break down the deduction by category. In Table 4.5 the ratio that is calculated is the average PV of the depreciation deduction divided by the amount of the deduction. This ratio allows for a standardized comparison of deductions across asset classes and investment values.!"#! Table 4.4 After Tax Present Value of Section 179 Summary Statistics by Farm-Type and Asset Class Crop Farms Dairy Farms Diversified Farms Asset Class Obs Mean Std Dev Min Max Obs Mean($) Std Dev Min Max Obs Mean($) Std Dev Min Max Total $ $ $ 3 16 660 983 36 3,824 4 1,072 1,437 68 3,206 3 857 312 518 1,132 23 5 70 797 1,219 5 6,400 40 847 1,328 5 6,290 25 873 1,748 1 8,617 135 7 155 3,790 6,659 20 34,377 80 3,684 6,295 16 39,156 32 6,297 10,857 9 54,710 267 10 9 1,682 2,227 7 6,197 30 5,793 12,036 52 54,426 14 2,251 2,924 105 8,081 53 15 55 2,043 1,879 100 8,787 9 2,355 4,040 3 12,473 11 1,635 1,113 298 3,275 75 Total 305 163 85 553 Table 4.5 After Tax Present Value Ratio of Section 179 Depreciation Deductions Crop Farms Dairy Farms Diversified Farms Asset Class Observations Ratio (%) Observations Ratio (%) Observations Ratio (%) Class 3 16 2 4 7 3 2 Class 5 70 4 40 5 25 4 Class 7 155 5 80 6 32 6 Class 10 9 4 30 8 14 6 Class 15 55 9 9 11 11 7 Total 305 163 85 Note: ATPV Ratio of Section 179 Depreciation (%) = (Average present value of Section 179 depreciation deduction/average amount of Section 179 depreciation deduction) !"#!In Table 4.4, the largest average ATPV per class was realized by diversified farms using class 7 property. The largest ATPV across all observations and farm types were $54,710. Crop farms most frequently used this deduction and did so most predominantly in class 7 property. Table 4.5 displays the mean ATPV ratios as a function of mean Section 179 depreciation deductions taken. The ATPV ratio (Average ATPV of depreciation deduction/average amount of Section 179 depreciation deduction), describes the relationship between the depreciation deduction taken and the benefit of the deduction. The ATPV ratio shows how much of the Section 179 depreciation deductions value was realized in the year the deduction was taken. This ratio also allows for comparison across asset classes and farms. A greater ATPV ratio represents a larger dollar-for-dollar benefit to the farmer. For example, an ATPV ratio of 3% provides a benefit of $0.03 on every dollar of deduction. The largest ATPV ratio of Section 179 depreciation deductions was realized by dairy farms when investing in 15-year property. Crop and diversified farms saw their largest ATPV Ratio of 9% in class 15 assets as well. In general, the longer asset classes had a higher ATPV ratio, providing greater value to the farmer. This is expected as the present value of deductions in longer-lived assets is greater than assets with shorter tax lives. 4.3 Bonus Depreciation Present Values Bonus depreciation has specific characteristics that make it different in the election from Section 179 depreciation deductions. These different characteristics, or rules, mean that the assets that Section 179 and Bonus depreciation are being used on are often different. To analyze the benefits received from Bonus depreciation deductions, this section, and the tables below identify Bonus depreciation deduction values by farm type, year, asset class and their associated after-tax present values. !""!Table 4.6 After Tax Present Value Summary Statistics of Bonus Depreciation Deductions Asset Class Observations Mean Standard Deviation Min Max $ 3 2 1,615 2,250 24 3,206 5 12 4,073 5,906 87 18,212 7 23 16,572 24,554 63 98,032 10 7 9,408 15,325 160 42,870 15 6 2,857 2,758 18 7,921 20 20 6,997 11,665 290 51,651 Total 70 Table 4.6 reveals that the highest number of ATPV Bonus depreciation allowances occurred in class 7 property followed closely by class 20 property. The high number of observations in 20-year property is largely attributed to the rules for electing Accelerated depreciation. To elect Accelerated depreciation on any assets in this class, farmers would have to use Bonus depreciation as non-single purpose property that does not qualify for Section 179 depreciation deductions. Class 7 had an average ATPV of $16,572 with the highest value being $98,032. Since Bonus depreciation requires the producer to take a fixed percent of the depreciable basis of new property, it is not surprising the mean ATPV of Bonus depreciation deductions was greater than Section 179 mean ATPV. !"#!Table 4.7 After Tax Present Value Bonus Depreciation Summary Statistics by Farm-Type and Asset Class Crop Farms Dairy Farms Diversified Farms Asset Class Obs Mean Std Dev Min Max Obs Mean Std Dev Min Max Obs Mean Std Dev Min Max Total $ $ $ 3 0 . . . . 1 3,206 . 3,206 3,206 1 24 . 24 24 2 5 4 759 701 87 1,613 7 6,491 6,879 405 18,212 1 403 . 403 403 12 7 10 3,106 3,170 63 9,245 11 26,253 29,623 1,828 98,032 2 30,655 34,018 6,601 54,710 23 10 2 570 579 160 979 5 12,943 17,248 590 42,870 0 . . . . 7 15 4 2,881 3,560 18 7,921 1 2,889 . 2,889 2,889 1 2,727 . 2,727 2,727 6 20 13 6,684 13,706 290 51,651 4 4,279 3,964 293 8,506 3 11,979 9,453 5,048 22,747 20 Total 33 29 8 70 Table 4.8 After Tax Present Value Ratio of Bonus Depreciation Deductions Taken Crop Farms Dairy Farms Diversified Farms Asset Class Observations PV Ratio (%) Observations PV Ratio (%) Observations PV Ratio (%) 3 0 . 1 4 1 1 5 4 2 7 5 1 2 7 10 7 11 8 2 24 10 2 3 5 11 0 . 15 4 23 1 15 1 15 20 13 13 4 27 3 19 Total 33 29 8 Note: ATPV Ratio of Bonus Depreciation(%) = (Average present value of Bonus depreciation deduction/average amount Bonus depreciation deduction!"#! Table 4.7 shows crop and dairy farms had a similar frequency of observations, with dairy farms average ATPV being much larger. When diversified farms did elect a Bonus deduction, it came at a much larger ATPV. Dairy farms had the highest maximum ATPV of Bonus depreciation of $98,032, which was realized on class 7 property. Class 20 property has the highest number of observations for crop farms and an ATPV of $6,684. Diversified farms had their largest average ATPV being realized in class 7 property of $30,655. Table 4.8 allows for a comparison between the observations of the Bonus depreciation deductions taken in each class by examining the ATPV ratio. This ratio is calculated the same as the ATPV ratio of Section 179 depreciation. The ratio is calculated by dividing the average after-tax present value of Bonus depreciation divided by the average amount of Bonus depreciation deduction. The ATPV ratio of Bonus depreciation for class 20 property of dairy farms was the highest across all farm types and asset classes at 27%, meaning a benefit of $0.27 was immediately realized for every dollar of Bonus depreciation deduction taken. Dairy farms realized the largest benefits in class 15 and 20 properties at 15% and 27% respectively. Diversified farms had the largest benefit in class 7 property with an ATPV ratio of 24%. Crop farms saw the greatest benefit in 15-year property with a PV ratio of 23%. Across all farm types and asset classes, farmers benefited from both forms of Accelerated depreciation deductions. The use of ATPV and ATPV ratios shows the immediately realized value of the deduction to the producer. 4.4 Cost of Capital Many studies examining the effect of tax policy on capital investment measured this effect using the cost of capital (Hall-Jorgenson, 1967). The cost of capital refers to the opportunity cost of making a specific investment. The cost of capital is the rate of return that !"$!could have been earned by putting the same money into a different investment or the cost of funds used to finance the business. Hall and Jorgenson (1967), refer to cost of capital as: !"#$%&'"(")*+&'")+ where: ¥!r is the rate of return the company requires to attract investors ¥!# is the inflation rate on capital goods ¥!% is the rate of economic depreciation ¥!) is the tax rate ¥!( is the investment credit rate ¥!* is the present value of depreciation deduction For r, the farms return on equity was assumed to be 0.06. The capital goods inflation rate, #, of 0.06 was used on class 3, 5 and 7 assets. An inflation rate of 0.03 was used for class 10, 15 and 20 year property. The inflation rates were calculated from the average percent change per year in the prices paid index from the United States Department of Agriculture National Agricultural Statistics Service from 2004-2014. The economic depreciation rate, %, comes from work done by Brazell and Mackie (2000), who purpose an economic depreciation life 12 years for machinery and equipment and 20 years for longer lived assets. These useful lives translate into an economic depreciation rate of 0.083 and 0.05 respectively. The statutory tax rate, ), used is the marginal IRS tax rate the farm uses dictated by their Schedule F net farm profit or loss assuming married, filing jointly tax status. No farms utilized investment credits, (, over this time period. To calculate z, the present value of the depreciation deduction, the present value of the depreciation deduction rate is calculated. To evaluate the cost of capital between MACRS depreciation and Accelerated depreciation deductions the tables below summarize the present !"%!value of the depreciation deduction rates for each asset class and year. These present values are used in the cost of capital calculation and show the current benefit producers realize from the use of the deduction. Accelerated depreciation PVs are calculated by subtracting the first year Accelerated depreciation deduction from the appropriate depreciable basis of the asset with the remaining adjusted depreciable basis applied to the appropriate MACRS depreciation schedule. To account for the change in percent of depreciable basis being deducted in each recovery period for MACRS depreciation caused by the larger first year Accelerated depreciation percentage, all subsequent MACRS depreciation rates are weighted by the percent of first year investment. This methodology is used is tables 4.10 and 4.11. Whereas the percent of first year Accelerated depreciation deductions is unique for each investment and Accelerated depreciation deduction decision, the values in tables 4.10 and 4.11 for Accelerated depreciation, Section 179 depreciation and Bonus depreciation are the average PV for each Accelerated depreciation deduction decision for that asset class and recovery period. !"#!Table 4.9 Average Present Value Depreciation Rates by Class and Recovery Period for MACRS and Accelerated Depreciation Tables MACRS Depreciation Rates MACRS with Accelerated Depreciation Rates Recovery Period Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 1 0.2500 0.1500 0.1071 0.0750 0.0500 0.0375 0.9431 0.8333 0.8210 0.8439 0.9072 0.7661 2 0.3472 0.2361 0.1771 0.1285 0.0880 0.0668 0.0264 0.0604 0.0470 0.0239 0.0095 0.0264 3 0.2143 0.1530 0.1289 0.1011 0.0733 0.0572 0.0163 0.0392 0.0342 0.0188 0.0079 0.0226 4 0.0992 0.1323 0.0972 0.0795 0.0611 0.0490 0.0075 0.0338 0.0258 0.0148 0.0066 0.0194 5 0 0.1225 0.0900 0.0642 0.0509 0.0420 0 0.0313 0.0239 0.0119 0.0055 0.0166 6 0 0.0567 0.0834 0.0595 0.0424 0.0360 0 0.0145 0.0221 0.0110 0.0046 0.0142 7 0 0 0.0772 0.0551 0.0372 0.0308 0 0 0.0205 0.0102 0.0040 0.0122 8 0 0 0.0358 0.0510 0.0344 0.0264 0 0 0.0095 0.0095 0.0037 0.0104 9 0 0 0 0.0472 0.0319 0.0241 0 0 0 0.0088 0.0034 0.0095 10 0 0 0 0.0437 0.0295 0.0223 0 0 0 0.0081 0.0032 0.0088 11 0 0 0 0.0202 0.0274 0.0207 0 0 0 0.0038 0.0029 0.0082 12 0 0 0 0 0.0253 0.0191 0 0 0 0 0.0027 0.0076 13 0 0 0 0 0.0235 0.0177 0 0 0 0 0.0025 0.0070 14 0 0 0 0 0.0217 0.0164 0 0 0 0 0.0023 0.0065 15 0 0 0 0 0.0201 0.0152 0 0 0 0 0.0022 0.0060 16 0 0 0 0 0.0093 0.0141 0 0 0 0 0.0010 0.0056 17 0 0 0 0 0 0.0130 0 0 0 0 0 0.0051 18 0 0 0 0 0 0.0121 0 0 0 0 0 0.0048 19 0 0 0 0 0 0.0112 0 0 0 0 0 0.0044 20 0 0 0 0 0 0.0103 0 0 0 0 0 0.0041 21 0 0 0 0 0 0.0048 0 0 0 0 0 0.0019 PV Per Class 0.9107 0.8505 0.7967 0.7251 0.6260 0.5467 0.9932 0.9707 0.9593 0.9536 0.9635 0.9567 !"$!Table 4.10 Average Present Value Depreciation Rates by Class and Recovery Period for Section 179 and Bonus Depreciation Tables Section 179 Depreciation Rates Bonus Depreciation Recovery Period Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 Class 3 Class 5 Class 7 Class 10 Class 15 Class 20 1 0.9569 0.8483 0.8253 0.8611 0.9204 0 0.6364 0.6541 0.7443 0.7357 0.7565 0.7661 2 0.0199 0.0567 0.0458 0.0217 0.0083 0 0.1684 0.1012 0.0676 0.0367 0.0225 0.0264 3 0.0123 0.0368 0.0333 0.0171 0.0069 0 0.1039 0.0656 0.0492 0.0289 0.0188 0.0226 4 0.0057 0.0318 0.0251 0.0134 0.0058 0 0.0481 0.0567 0.0371 0.0227 0.0157 0.0194 5 0 0.0294 0.0233 0.0109 0.0048 0 0 0.0525 0.0344 0.0184 0.0131 0.0166 6 0 0.0136 0.0215 0.0101 0.0040 0 0 0.0243 0.0318 0.0170 0.0109 0.0142 7 0 0 0.0199 0.0093 0.0035 0 0 0 0.0295 0.0157 0.0095 0.0122 8 0 0 0.0092 0.0086 0.0032 0 0 0 0.0137 0.0146 0.0088 0.0104 9 0 0 0 0.0080 0.0030 0 0 0 0 0.0135 0.0082 0.0095 10 0 0 0 0.0074 0.0028 0 0 0 0 0.0125 0.0076 0.0088 11 0 0 0 0.0034 0.0026 0 0 0 0 0.0058 0.0070 0.0082 12 0 0 0 0 0.0024 0 0 0 0 0 0.0065 0.0076 13 0 0 0 0 0.0022 0 0 0 0 0 0.0060 0.0070 14 0 0 0 0 0.0020 0 0 0 0 0 0.0056 0.0065 15 0 0 0 0 0.0019 0 0 0 0 0 0.0052 0.0060 16 0 0 0 0 0.0009 0 0 0 0 0 0.0024 0.0056 17 0 0 0 0 0 0 0 0 0 0 0 0.0051 18 0 0 0 0 0 0 0 0 0 0 0 0.0048 19 0 0 0 0 0 0 0 0 0 0 0 0.0044 20 0 0 0 0 0 0 0 0 0 0 0 0.0041 21 0 0 0 0 0 0 0 0 0 0 0 0.0019 PV Per Class 0.9949 0.9733 0.9602 0.9587 0.9687 0 0.9567 0.9392 0.9418 0.9215 0.9042 0.9567 !"#!Table 4.9 shows greater present values from Accelerated depreciation use over strict MACRS use for all asset classes. The difference between the PV of Accelerated depreciation and MACRS PV increases as the assets useful life increases. Class 3 assets see an increase of 0.0825 from Accelerated depreciation use. Class 5 assets have an increase of 0.1202 in PV and this difference monotonically increases over 7, 10 and 15-year property with class 20 assets showing a 0.41 increase in PV from Accelerated depreciation use. The use of Accelerated depreciation shows a positive PV increase to producers when they elect any form of Accelerated depreciation. Table 4.10 shows a greater PV for Section 179 depreciation deductions. No class 20 property is eligible for Section 179 depreciation deductions. The higher PV from Section 179 depreciation deductions can be explained by the ability to deduct 100% of the depreciable basis of the investment in the first year where Bonus depreciation allows for a specific percent, often less than 100, to be deducted. Bonus depreciation shows one of its highest PV in class 20 property. From the PV in tables 4.9 and 4.10, the cost of capital is calculated for MACRS depreciation, Accelerated depreciation, Section 179 depreciation and Bonus depreciations. Table 4.11 Summary Statistics for Cost of Capital with MACRS Depreciation Asset Class Observations Mean Std. Dev. Min Max Cost of Capital Class 3 63 0.0857 0.0012 0.0838 0.0879 Class 5 317 0.0876 0.0021 0.0844 0.0911 Class 7 353 0.0889 0.0029 0.0849 0.0941 Class 10 132 0.0887 0.0036 0.0824 0.0944 Class 15 125 0.0916 0.0049 0.0833 0.0996 Class 20 123 0.0837 0.0015 0.0810 0.0861 Total 1,113 The cost of capital for traditional MACRS depreciation in Table 4.11 provides reference points for Accelerated depreciation cost of capital changes. The highest cost of capital is class !"$!15 assets with the lowest being class 20. Table 4.11 shows the cost of capital for every asset class has a small standard deviation. Table 4.12 Cost of Capital by Class for Accelerated Depreciation Use Asset Class Observations Mean Std. Dev. Min Max Cost of Capital Class 3 24 0.0832 0.0007 0.083 0.0853 Class 5 144 0.0840 0.0017 0.0815 0.0892 Class 7 279 0.0842 0.0022 0.0728 0.0919 Class 10 59 0.0817 0.0029 0.08 0.0898 Class 15 80 0.0813 0.0032 0.08 0.0939 Class 20 20 0.0816 0.0011 0.08 0.0830 Total 606 Table 4.12 shows that when accounting for the use of Accelerated depreciation, the mean cost of capital has decreased overall asset classes as compared to the MACRS cost of capital. Class 15 assets have the lowest cost of capital at 0.0813. The highest average cost of capital with Accelerated depreciation use is class 7 property. To learn of the influence from each part of Accelerated depreciation, Table 4.13 provides the average cost of capital for Section 179 and Bonus depreciation deductions. !"%!Table 4.13 Cost of Capital by Asset Class for Section 179 and Bonus Depreciation Deductions Section 179 Bonus Asset Class Obs. Mean Std. Dev. Min Max Obs. Mean Std. Dev. Min Max Difference Cost of Capital Cost of Capital Class 3 23 0.0832 0.0006 0.083 0.0853 2 0.0848 0.0007 0.0842 0.0853 0.0016 Class 5 135 0.0839 0.0016 0.083 0.0892 12 0.0853 0.0019 0.0815 0.0875 0.0014 Class 7 267 0.0842 0.0021 0.0825 0.0919 23 0.0848 0.0034 0.0728 0.0890 0.0006 Class 10 53 0.0815 0.0028 0.08 0.0898 7 0.0835 0.0033 0.08 0.0872 0.002 Class 15 75 0.0810 0.0028 0.08 0.0939 6 0.0847 0.0052 0.08 0.0905 0.0037 Class 20 0 20 0.0816 0.0011 0.08 0.0830 0.0816 Total 553 70 Differencea= Bonus cost of capital-Section 179 cost of capital When looking at Section 179 and Bonus depreciation deductions cost of capital, Section 179 has a lower cost of capital over every eligible asset class. The largest difference between Section 179 and Bonus depreciation costs of capital is found in class 15 property. Table 4.14 shows all farm types with the similar average cost of capital when looking across all asset classes when Section 179 depreciation was used. Table 4.15 again shows the average cost of capital by farm type is fairly consistent when utilizing Bonus depreciation. !"#!Table 4.14 Cost of Capital by Farm-Type and Asset Class for Section 179 Depreciation Deductions Crop Farms Dairy Farms Diversified Farms Asset Class Obs Mean Std Dev Min Max Obs Mean Std Dev Min Max Obs Mean Std Dev Min Max Total Cost of Capital Cost of Capital Cost of Capital Class 3 16 0.0831 0.0005 0.0830 0.0851 4 0.0836 0.0011 0.0830 0.0853 3 0.0830 0.0000 0.0830 0.0830 23 Class 5 70 0.0836 0.0013 0.0830 0.0889 40 0.0844 0.0020 0.0830 0.0892 25 0.0840 0.0016 0.0830 0.0873 135 Class 7 155 0.0841 0.0020 0.0830 0.0910 80 0.0843 0.0020 0.0825 0.0900 32 0.0844 0.0026 0.0830 0.0919 267 Class 10 9 0.0804 0.0013 0.0800 0.0838 30 0.0820 0.0032 0.0800 0.0898 14 0.0810 0.0023 0.0800 0.0875 53 Class 15 55 0.0812 0.0032 0.0800 0.0939 9 0.0800 0.0000 0.0800 0.0800 11 0.0809 0.0020 0.0800 0.0862 75 Total 305 163 85 553 Table 4.15 Cost of Capital by Farm-Type and Asset Class for Bonus Depreciation Deductions Crop Farms Dairy Farms Diversified Farms Asset Class Obs Mean Std Dev Min Max Obs Mean Std Dev Min Max Obs Mean Std Dev Min Max Total Cost of Capital Cost of Capital Cost of Capital Class 3 0 . . . . 1 0.0853 . 0.0853 0.0853 1 0.0842 . 0.0842 0.0842 2 Class 5 4 0.0843 0.0026 0.0815 0.0875 7 0.0860 0.0014 0.0833 0.0872 1 0.0841 . 0.0841 0.0841 12 Class 7 10 0.0851 0.0020 0.0830 0.0885 11 0.0847 0.0046 0.0728 0.0890 2 0.0836 0.0008 0.0830 0.0842 23 Class 10 2 0.0857 0.0004 0.0854 0.0859 5 0.0826 0.0036 0.0800 0.0872 0 . . . . 7 Class 15 4 0.0820 0.0040 0.0800 0.0881 1 0.0898 . 0.0898 0.0898 1 0.0905 . 0.0905 0.0905 6 Class 20 13 0.0812 0.0012 0.0800 0.0830 4 0.0823 0.0006 0.0815 0.0829 3 0.0822 0.0007 0.0818 0.0830 20 Total 33 29 8 70 !""! Table 4.16 Cost of Capital by Asset Class Across Years for MACRS Depreciation Asset Class Obs 2004 Obs 2005 Obs 2006 Obs 2007 Obs 2008 Obs 2009 Obs 2010 Obs 2011 Obs 2012 Obs 2013 Obs 2014 Total Class 3 6 0.086 8 0.086 9 0.086 4 0.085 8 0.086 5 0.085 4 0.084 7 0.086 3 0.087 5 0.086 4 0.087 63 Class 5 30 0.088 28 0.087 36 0.087 29 0.088 26 0.087 37 0.087 27 0.087 21 0.088 27 0.088 29 0.088 27 0.088 317 Class 7 36 0.088 36 0.089 41 0.089 35 0.089 35 0.088 28 0.089 31 0.088 24 0.090 25 0.090 30 0.090 32 0.090 353 Class 10 12 0.087 8 0.088 15 0.087 17 0.090 19 0.089 14 0.088 10 0.087 8 0.090 12 0.090 13 0.090 4 0.093 132 Class 15 9 0.091 7 0.091 7 0.089 14 0.093 7 0.094 17 0.091 11 0.088 15 0.092 10 0.094 15 0.091 13 0.093 125 Class 20 5 0.083 6 0.084 12 0.083 12 0.083 17 0.084 16 0.083 6 0.083 10 0.083 10 0.084 11 0.084 18 0.084 123 Total 98 93 120 111 112 117 89 85 87 103 98 1,113 Table 4.17 Cost of Capital by Asset Class Across Years for Section 179 Depreciation Deductions Taken Asset Class Obs 2004 Obs 2005 Obs 2006 Obs 2007 Obs 2008 Obs 2009 Obs 2010 Obs 2011 Obs 2012 Obs 2013 Obs 2014 Total Class 3 1 0.083 1 0.083 4 0.084 2 0.083 3 0.083 0 . 1 0.083 3 0.083 2 0.083 4 0.083 2 0.084 23 Class 5 8 0.084 15 0.084 8 0.084 11 0.084 12 0.084 12 0.084 10 0.083 14 0.084 11 0.085 19 0.084 15 0.084 135 Class 7 22 0.085 25 0.084 18 0.084 27 0.084 25 0.084 8 0.084 24 0.084 28 0.084 33 0.085 29 0.084 28 0.084 267 Class 10 5 0.082 8 0.083 3 0.085 3 0.080 4 0.081 2 0.080 3 0.080 9 0.080 4 0.081 5 0.082 7 0.081 53 Class 15 2 0.082 7 0.080 5 0.080 5 0.080 7 0.080 5 0.083 7 0.080 7 0.080 15 0.082 7 0.082 8 0.082 75 Total 38 56 38 48 51 27 45 61 65 64 60 553 Table 4.18 Cost of Capital by Asset Class Across Years for Bonus Deduction Deductions Taken Asset Class Obs 2004 Obs 2005 Obs 2006 Obs 2007 Obs 2008 Obs 2009 Obs 2010 Obs 2011 Obs 2012 Obs 2013 Obs 2014 Total Class 3 0 . 0 . 0 . 0 . 0 . 0 . 0 . 0 . 1 0.084 0 . 1 0.085 2 Class 5 5 0.086 0 . 0 . 0 . 2 0.086 0 . 0 . 2 0.082 1 0.086 1 0.083 1 0.087 12 Class 7 5 0.086 0 . 0 . 0 . 1 0.082 0 . 3 0.087 3 0.080 5 0.086 3 0.084 3 0.085 23 Class 10 2 0.086 0 . 0 . 0 . 0 . 0 . 1 0.080 2 0.080 1 0.086 0 . 1 0.087 7 Class 15 0 . 0 . 0 . 0 . 0 . 0 . 0 . 3 0.080 1 0.088 1 0.091 1 0.090 6 Class 20 5 0.082 0 . . 0 . 1 0.082 1 0.081 4 0.081 3 0.080 3 0.082 2 0.083 1 0.082 20 Total 17 0 0 0 4 1 8 13 12 7 8 70 !!"#! Tables 4.16, 4.17 and 4.18 allow for a comparison of the cost of capital between different depreciation elections for the same year and asset class. Over the years, the cost of capital remains consistent within each depreciation type. One of the biggest changes in the cost of capital between years comes from Bonus depreciation in 2011when there was a decrease in the cost of capital in all asset classes, potentially due to the 100% Bonus depreciation deduction allowed that year. The large policy changes in Section 179 depreciation happened between 2006-2007, 2007-2008, and 2009-2010. Between 2006 and 2007 there was a slight decrease in the cost of capital for class 3 and 10-year property. From 2007-2008, there was little to no change in the cost of capital. The largest Section 179 policy expansion in 2009-2010 saw a modest reduction in 5 and 15-year property. Table 4.19 Average Cost of Capital by Depreciation Type MACRS Depreciation Accelerated Depreciation Section 179 Depreciation Bonus Depreciation Asset Class Cost of Capital Cost of Capital Percent Change Cost of Capital Percent Change Cost of Capital with Percent Change 3 0.0857 0.0832 -2.92 0.0832 -2.92 0.0848 -1.05 5 0.0876 0.0840 -4.11 0.0839 -4.22 0.0853 -2.63 7 0.0889 0.0842 -5.29 0.0842 -5.29 0.0848 -4.61 10 0.0887 0.0817 -7.89 0.0815 -8.12 0.0835 -5.86 15 0.0916 0.0813 -11.24 0.0810 -11.57 0.0847 -7.53 20 0.0837 0.0816 -2.51 . . 0.0816 -2.51 Note: Percent Change = change from MACRS Depreciation Cost of Capital Table 4.19 provides a side by side comparison of the depreciation types as well as the difference between the respective type and MACRS depreciation. The average MACRS depreciation cost of capital is calculated from the investments that used no accelerated depreciation. The forms of accelerated depreciation were calculated conditionally on use. Accelerated, Section 179 and Bonus depreciation each lowered the cost of capital. The greatest decrease in the cost of capital came from the use of Section 179 depreciation deductions. These !!"$!deductions drove down the average Accelerated depreciation cost of capital. When Section 179 depreciation deductions were eligible, the reduction in the cost of capital increases as asset lives increased. This means that Section 179 depreciation deductions lower the opportunity cost of a purchases more for longer lives assets than they do for shorter ones, thus incentivizing greater investments in longer-lived items. The greater decrease caused by Section 179 depreciation can be largely attributed to the policy characteristics of the deduction. Section 179 allows producers to deduction 100% of the depreciable basis of property in the first year if eligible. Bonus depreciation dictates a percent of depreciable basis be claimed in the first year. Section 179Õs potential for larger weighting of first-year depreciation deductions shows to drive up the PV of the depreciation deduction thus driving down the cost of capital. The greatest decrease in the cost of capital occurred in 15-year property when Section 179 depreciation was used. The cost of capital decreased by 11.57% compared to utilizing MACRS depreciation alone. These tax policy incentives have proven to provide a benefit to farmers in both the present value of the depreciation deduction as well as a reduction in the cost of capital when an investment decision is made. Table 4.20 calculates the changes in cost of capital with r set at the actual long-term ROE for each operation. The MACRS cost of capital, is the cost of capital the farmer would have had if they would not have utilized the accelerated deprecation deduction. Table 4.20 assumes the use of the farms average ROE with a lower ROE limit of 6% and an upper limit of 11%. The calculation also assumes a 3% inflation rate on capital good for class 3, 5, and 7 property and 6% inflation for class 10, 15 and 20 year property. The results share the same pattern as table 4.19 in that as asset classes lengthen the cost of capital decreases with the use of the accelerated deprecation deduction. !!"#! Table 4.20 Average Cost of Capital by Depreciation Type: Internal ROE of 6-11% Accelerated Depreciation Section 179 Depreciation Bonus Depreciation Asset Class Obs MACRS Cost of Capital Acc Dep Cost of Capital Percent Change Obs MACRS Cost of Capital Sec 179 Cost of Capital Percent Change Obs MACRS Cost of Capital Bonus Cost of Capital Percent Change 3 24 0.1341 0.1292 -3.66 23 0.1340 0.1290 -3.76 2 0.1389 0.1358 -2.20 5 144 0.1293 0.1235 -4.51 135 0.1289 0.1230 -4.60 12 0.1372 0.1324 -3.51 7 279 0.1293 0.1216 -5.96 267 0.1292 0.1216 -5.94 23 0.1337 0.1249 -6.62 10 59 0.1331 0.1223 -8.14 53 0.1315 0.1206 -8.27 7 0.1474 0.1357 -7.97 15 80 0.1421 0.1239 -12.84 75 0.1411 0.1229 -12.95 6 0.1569 0.1377 -12.22 20 20 0.1402 0.1253 -10.62 . . 20 0.1402 0.1253 -10.62 Note: Percent Change = change from MACRS Depreciation Cost of Capital ROE in the average internal ROE with a lower limit of 6% and upper limit is 11% !!"#!4.5 Effect on Investment To measure the responsiveness of farm investment to the depreciation tax policy changes, economists use the elasticity of investment. Investment elasticity is the percentage change in investment with respect to the percentage change in the user cost of capital. Lui found that the elasticity was -2.0 in some cases, meaning a one percent decrease in the cost of capital would result in a two percent increase in investment. Hassett and Hubbard (2002) reviewed the literature on the effect of tax policy on business investment and concluded that the elasticity of investment on the tax-adjusted user cost of capital is between -0.5 and -1.0. Using the range of investment elasticity suggested by Hassett and Hubbard, Table 4.21 displays the resulting increase in investment by asset class for both types of Accelerated depreciation together, then Section 179 and Bonus depreciation independently. Table 4.21 Investment Responses Relative to MACRS Depreciation Accelerated Depreciation Section 179 Depreciation Bonus Depreciation Investment Elasticity Asset Class -0.5 -1.0 -0.5 -1.0 -0.5 -1.0 % change 3 1.46 2.92 1.46 2.92 0.53 1.05 5 2.06 4.11 2.11 4.22 1.32 2.63 7 2.65 5.29 2.65 5.29 2.30 4.61 10 3.94 7.89 4.06 8.12 2.93 5.86 15 5.62 11.24 5.79 11.57 3.76 7.53 20 1.26 2.51 . . 1.26 2.51 Note: Percent Change = change from investment under MACRS Depreciation. The largest responses in investment occur in the 10 and 15-year property although seven year property also has a relatively large response to accelerated depreciation. Section 179 is driving more investment than Bonus depreciation. If expansion of these policies is driven by the !!"$!desire to decrease the cost of capital farmers face when making an investment decision, then it appears to be working. !!"%!Chapter 5. Summary and Conclusions In 1981, the IRS tax code changed to allow for Section 179 Accelerated depreciation deductions. In 2002, Bonus depreciation was added as an additional form of first-year depreciation. These changes were initially created to incentive the investments made in equipment. While the agricultural industry is not the only beneficiary of Accelerated depreciation deductions, it has become commonplace for farmers to take advantage of the deductions available to them. With the widespread use of these tax tools that are designed to decrease the taxable incomes of farmers, it is important to quantify the benefits producers are receiving. In this panel data set of 66 farms spanning 11 years, there have been 305 Section 179 depreciation deductions taken with an average value of $52,250 and 70 Bonus depreciation deductions taken with an average value of $100,886. Over the 11 year time period, there has been 7 Section 179 depreciation tax policy changes and four Bonus depreciation policy changes. Changes in policy levels signal governmental preferences towards increased or decreased business investment. A driver of investment is the return a firm receives from the addition of a new capital asset. This paper quantified the benefits a farm receives from the addition of Accelerated depreciation when an investment is made. This has been done through present value analysis of the depreciation deduction and via depiction of the reduction in the cost of capital. The present value of the depreciation deduction is the immediate benefit the farmer receives from electing an Accelerated depreciation deduction. The present value is multiplied by the tax rate to account for the farmers true depreciation deduction value. These present values of depreciation deductions offer farmers a large benefit in the year investment is made. The average after-tax present value of $6,997 for a Bonus depreciation deduction when investment in !!"&!Class 20 property is made means that the producer is receiving $6,997 worth of value in the current year by electing the Bonus depreciation over utilizing MACRS depreciation alone. This immediate depreciation benefit then translates into a decreased cost of investment for the producer. This change in cost can be captured by calculating the cost of capital. The cost of capital represents the opportunity cost the farmer faces when making an investment in the business. The internal cost of capital dictates the businesses required a return from the investment they are making. If the cost of the asset they are deciding to invest in can be lowered through Accelerated depreciation deductions, the business can more easily generate the required return from that asset, thus increasing the likelihood of capital investment. This paper calculated the decrease in cost of capital that was attributed to Accelerated depreciation deductions. Use of Accelerated depreciation created an average decrease in the cost of capital of up to 11.24%. For the most frequently invested in the asset class, class 7, there was a 5.29% decrease in the cost of capital from using Accelerated depreciation. These immediate benefits in present value that translate into a decrease in the cost of capital for farmers from the election of Accelerated depreciation are worth noting. Farmers are seeing large benefits from these tax policies, especially in years of high net farm income. With Section 179 maximum expense and investment limits monotonically increasing over the life of the policy, it is important to know the resulting producer benefits. If the expansion of these policies is driven by the desire to decrease the cost of capital farmers face when making an investment decision, then it appears to be working. Further research would need to be done to form any conclusions on Accelerated depreciation deductions role in farmer investment behavior. !!"'! APPENDIX !!"(! 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