The IRS will allow a farmer that is exempt from the uniform capitalization (UNICAP) rules by reason of having average annual gross receipts of $25 million or less to revoke a prior election out of the UNICAP rules made under Code Sec. 263A(d)(3) with respect to pre-productive plant expenditures. The guidance also explains how a farmer may make an election out under Code Sec. 263A(d)(3) in a tax year in which the farmer is no longer exempt from the UNICAP rules as a qualifying small business taxpayer with $25 million or less in average annual gross receipts.
Revocation of the prior election out is beneficial because a farmer that makes the election must depreciate farm property placed in service during any tax year the election is in effect using the MACRS alternative depreciation system (ADS). ADS requires use of the straight-line method over depreciation periods that are generally longer than those that apply under the MACRS general depreciation system (GDS) if the election out is not made ( Code Sec. 263A(e)(2)). If the election out is revoked, a qualifying small business farmer remains exempt from the UNICAP rules under the $25 million gross receipts test but is no longer required to use ADS on existing or newly acquired property by reason of the prior election out.
In addition, a rule that treats all plants produced by the farmer as section 1245 property, and requires ordinary income recapture to the extent of deductions otherwise required to be capitalized, no longer applies to new plantings after revocation of the election out is made ( Code Sec. 263A(e)(1)).
The election out may be revoked by a farmer that:
- is exempt from the UNICAP rules by reason of the $25 million average gross receipts test for qualifying small business taxpayers (as described in Code Sec. 448(c) and provided by Code Sec. 263A(i), as added by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), effective for tax years beginning after 2017);
- previously made the election out of UNICAP under Code Sec. 263A(d)(3); and
- wants to apply the $25 million gross receipts exemption for small business taxpayers in the same tax year that it revokes the Code Sec. 263A(d)(3) election out.
An eligible small business farmer receives IRS consent to revoke a prior election out by continuing not to capitalize costs under the UNICAP rules on its original tax return (including extensions) for the tax year of the revocation of the election out, continuing to treat plantings in prior tax years as section 1245 property, and changing the depreciation method of farm property from ADS to GDS as explained below.
Special rule for 2018 tax year. A small business farmer that already filed a timely 2018 return may revoke the election out in the 2018 tax year by filing an amended 2018 return (an administrative adjustment request in the case of certain partnerships) before filing a 2019 return. Alternatively, Form 3115, Application for Change in Accounting Method, may be filed with a timely income tax return for the first, second, or third tax year following the 2018 tax year.
Changing From ADS to GDS
A farmer revoking the election out may cease using ADS to depreciate its existing farming property beginning in the year the election out is revoked, and ADS will not apply to farm property placed in service in the revocation year or thereafter. The switch from ADS to GDS is made using the MACRS change in use rules ( Reg. §1.168(i)-4(d)) and, therefore, the GDS method applies prospectively on the remaining basis of the farm property. The change in use rules, however, allow a farmer to elect to continue to depreciate its existing property using ADS. Property switched from ADS to GDS is not eligible for bonus depreciation. A farmer may make an ADS election for classes of newly acquired property under the usual ADS election rules.
A farmer revoking the election out has adopted an impermissible accounting method if it continues to use ADS in the revocation year and the following tax year (unless the election to continue using ADS was made under the change in use rules). In this case, a farmer must file Form 3115 and compute a section 481 adjustment as if the switch from ADS to GDS had been made in the revocation year. Similarly, a farmer that depreciates newly acquired property using ADS in the revocation year and the following year has adopted an impermissible method that must be corrected by filing Form 3115 unless a valid ADS election was made.
Losing Exemption Under Gross Receipts Test
The guidance allows a small business farmer to make a Code Sec. 263A(d)(3) election out of the UNICAP rules in the first tax year the farmer no longer qualifies for exemption under the $25 million average gross receipts test. The election out is made on the original tax return (including extensions) using the currently prescribed election Code Sec. 263A(d)(3) procedures, and by continuing not to capitalize costs under the UNICAP rules.
The electing farmer must use ADS to depreciate property placed in service in the election out year and subsequent years. Bonus depreciation may not be claimed on this property. An election out is not valid if ADS is not used to depreciate this property. ADS does not apply to property placed in service during tax years prior to the election out year.
The guidance is generally effective on February 21, 2020. Transition guidance is provided for taxpayers that filed a Form 3115 on or before February 21, 2020, to obtain consent to revoke a Code Sec. 263A(d)(3) election.
Rev. Proc. 2019-43, I.R.B. 2019-48, 1107, which lists the automatic accounting method changes, is modified to included certain accounting method changes described in the guidance.