Recently, there has been renewed interest in a tax strategy involving excess fertilizer in farmland. The idea behind this strategy is to allocate a value to any residual fertilizer in farmland that was recently purchased or inherited. The value of the fertilizer is then deducted to offset income. While this strategy does have merit, it is considered by some tax professionals to be an aggressive tax strategy and caution should be used when implementing.
This strategy is centered on excess fertilizer being in the soil when farmland is acquired. Excess fertilizer is that amount of fertilizer over and above the base nutrient levels. The excess fertilizer is treated as a separate asset that can be distinguished from the soil. A value is attributed to the excess fertilizer and that value is amortized based on the depletion rate of the fertilizer. In essence, the new owner of the farmland is claiming they can put a verifiable value on the excess fertilizer and then amortize the value of the fertilizer.
In a 1992 Technical Advice Memorandum (TAM), the IRS stated that to amortize the cost of fertilizer acquired with land, the landowner must establish the extent of the fertilizer, the value of the fertilizer and the depletion rate of the soil nutrients. The burden is on the taxpayer seeking the deduction to prove the extent, value and depletion rate of the soil nutrients. It is important to note that a TAM is not legal authority and cannot be cited as authority, but it does potentially give insight as to the position the IRS would take in a similar matter.
To help explain this concept, consider the following example:
Arthur applied $15,000 of fertilizer to his farm in November 2022 in anticipation of growing a crop in 2023. In January 2023, Arthur dies unexpectedly, and his son Alex inherits the farm. Alex is a farmer and intends to grow a corn crop on the farm in 2023. Alex hires an agronomist who determines that all the fertilizer applied by Arthur is in excess of base nutrient levels and will be depleted over a three-year period. Alex deducts the $15,000 of excess fertilizer in 2023, 2024 and 2025.
If an attempt is made to deduct excess fertilizer, something like the above example is an ideal scenario. The fertilizer applied is easily documented, no crop has yet been planted, and the agronomist can establish the depletion rate. All aspects of the strategy should be carefully documented, including a report from the agronomist. Peril awaits those who implement this strategy after they have applied additional fertilizer, grown a crop or can otherwise not properly document the excess fertilizer and/or depletion rate.
While the above example uses an inherited farm, the same strategy can be used with purchased farms. Farms purchased at public auction may sell for a premium if excess fertilizer is present. The premium, if properly documented, can potentially be deducted as excess fertilizer. For farms purchased at private sale, the buyer and seller should address excess fertilizer in the purchase contract and declare a mutually agreeable amount and value. If the buyer allocates a portion of the purchase price to excess fertilizer but the seller does not, the inconsistency in reporting could cause the IRS to deny the strategy.
While identifying excess fertilizer can be a benefit to the buyer, it may be detrimental to the seller. The seller should treat the excess fertilizer as a sale of fertilizer which is subject to ordinary income and thus possibly a higher tax rate. Thus, the seller may be reluctant to participate in allocating a portion of the purchase price to excess fertilizer. Also, if the buyer were to sell the land in the future, they will need to recapture the excess fertility as ordinary income.
As stated above, allocating a value to excess fertilizer in newly acquired farmland does have merit. However, this strategy has never been formally approved by the IRS and, until it is, comes with the risk that the IRS could reject the deduction of excess fertilizer. Additionally, states are not obligated to follow the IRS’ lead and one state, Minnesota, has a history of closely scrutinizing the strategy. For anyone considering implementing this strategy, they should seek advice from their tax advisor to minimize risks of an adverse IRS ruling and employ an experienced agronomist or soil scientist to provide technical guidance on fertilizer levels and depletion rate. In addition to seeking good, qualified advice, the landowner should be sure that every aspect of the strategy is well documented.
Note: this strategy can apply to any addition to the soil such as lime or micronutrients.
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