IRS Loophole Leads to Tax Deductions for Excessive Water Use

A report from ProPublica detailing the water crisis in the American West highlighted some confounding contradictions that only serve to worsen the problem. In parts of the western U.S., you can actually get a tax break for using an abundance of water, thanks to an IRS loophole.

As shocking as it sounds, this isn’t a joke. Meanwhile, the Colorado River is trickling, its largest reservoirs closer to empty than full, and groundwater aquifers from California to Nebraska are being sucked dry. The National Academy of Sciences predicts the Southwest could be on the cusp of its worst dry spell in 1,000 years. Despite the gravity of the situation, this tax break exists in parts of eight High Plains states.

‘Depleted Assets’ IRS Loophole

It works like this: Farmers – or anyone who uses water in business – can ask the IRS for a tax write-off for what’s called a ‘depleted asset.’ Because water counts as an asset in certain jurisdictions, as more water is used the farmers can claim more cash credits against their income tax.

And that is precisely what almost 3,000 Texas landowners in a single water district did last year, a year in which almost half of the state was in a “severe” or “extreme” drought.

Water as an Asset

So, when did this depleted assets tax break originate? About 50 years ago, a farmer in the Texas panhandle, along with his local water district, sued the IRS. His argument was that the roughly 200 million gallons he drew from his groundwater each year was no different from the state’s other great natural resource, oil. He won the suit, and the IRS subsequently created rule 65-296, a special allowance for tax credits.

The allowance was supposed to be limited to a slice of Texas and eastern New Mexico, and the court even warned that the case shouldn’t be a precedent for groundwater tax claims in other areas. But soon after, the rule was expanded. By the mid-1980s any landowner overlying the Ogallala aquifer, which sits under large portions of eight states from Wyoming and South Dakota down to Texas, was eligible for tax deductions.

How Much can be Deducted?

A whole lot, it appears. According to one accountant in Levelland, Texas, a single client of his wrote off $10,000. When land is purchased, the dirt, and whatever lies under it, is purchased as well. If the aquifer was 50 feet deep at the time of the land sale, and it drops 10 feet in a year, one-fifth of the value can be deducted, and so on, until all the water is used.

Estate Planning & Tax Preparation with Cohen & Burnett

While this tax deduction in particular is surrounded by unique circumstances, it does help to know which tax deductions apply to you and your situation. As a prominent Estate Planning and Estate Administration Law Firm, Cohen & Burnett prepares numerous federal tax returns, including:

● 1040 personal income tax
● 1041 estate or trust income tax return
● 1065 partnership income tax return
● 706 estate tax return
● 709 gift tax return

To learn about our legal planning, tax strategy, and estate planning services, please visit our homepage today!

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