Consider the Risks When Taking a Residual Fertility Deduction
There’s been much recent discussion about a “residual fertility” deduction for farm and ranchland. It’s been common practice among farmers for many years to take a tax deduction for the value of unexhausted fertilizer remaining in soil purchased with land. In recent years, however, this practice has expanded to include large deductions for the value of all soil nutrients, not necessarily those linked to prior fertilization. Questions about the legal basis for these deductions have increased as the value of these deductions have risen.
Fertilizer Expenditures and Section 180
To understand this issue, it is important to understand the basis for deducting fertilizer in the first place. Years ago, the IRS required farmers to capitalize and deduct fertilizer costs over the useful life of the fertilizer. Because the fertilizer would not be used up in one year, the deductions had to be spread out. In 1960, Congress changed course, recognizing that farmers would benefit from deducting fertilizer expenses in the year paid. Section 180 thus allows farmers to elect to deduct in the year of application the cost of fertilizer, lime, and similar materials applied to land used in farming.
Residual Fertilizer Supply
When farmland is purchased, a buyer may allocate part of the price to depreciable assets such as fencing or tile. Many farmers have also assigned a portion of the purchase price to the value of unexhausted fertilizer and deducted that expense accordingly. Although there is no statute, court case, or regulation specifically endorsing this practice, a 1991 IRS memorandum suggests this deduction is appropriate if properly proved.
In TAM 9211067, the IRS denied a claimed deduction for unexhausted fertilizer purchased with the land, but outlined requirements to support a possible deduction. The taxpayer must: (1) prove the presence and extent of fertilizer attributable to the prior owner, (2) show that the fertilizer is being exhausted, and (3) be the beneficial owner of the fertilizer, meaning it is inseparable from land the taxpayer owns.
If a farmer who purchases land can meet these three conditions, it appears they can elect under §180 to expense the value of the unexhausted fertilizer in the year of purchase, much like other purchased fertilizer, provided the land is used in farming and the taxpayer is engaged in the business of farming.
A Caution
In recent years, land purchasers have ventured beyond these parameters to take very large deductions based on the total nutrient content of the soil, not based upon the value of unexhausted fertilizer. These deductions are risky. Courts have stated that land alone, including the nutrients that comprise that soil, are not depreciable. Likewise, courts have not allowed depletion deductions for the decline of soil nutrients. Section 180 applies only to fertilizer applied to enrich the soil, and by extension, to unexhausted fertilizer in the soil.
Expansive claims based on general soil nutrients or inflated valuations may invite IRS scrutiny and penalties. Taxpayers bear the burden of proving they are entitled to any deductions they take. Deductions tied to land purchased many years ago or to unfertilized pastureland are especially vulnerable. Until Congress, the courts, or the IRS provide clear guidance, farmers and land purchasers should seek trusted counsel and weigh the risks of asserting a deduction for residual fertility.
Additional Resources
There are a number of additional resources related to the Section 180 tax deduction.
- Ag Law in the Field Podcast episode
- Considering the Residual Fertility Deduction
- Deducting Residual Fertility Presentation
- What is IRS Section 180 and How Does It Work?
Many of your local Land Grant institutions offer annual tax workshops for tax professionals. For locations around the country: Land Grant Tax Workshops
And specifically for workshops in our two states: Texas and Iowa
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