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After much anticipation, the Federal Aviation Administration (FAA) has published proposed regulations that would govern the operation of drones used for agricultural and other activities.  The proposal would allow farmers and ranchers to operate drones, referred to in the rule as “unmanned aircraft” and “unmanned aircraft systems” (UAS), subject to requirements intended to address public safety and national security concerns.  

Under the proposed small UAS rule, operators must comply with a certification process, register and maintain aircraft, and follow limitations on aircraft operation. Of the proposed limitations, agricultural operators might have concerns about a “visual line-of-sight” rule requiring that operators have visual contact with aircraft, a flight ceiling of 500 feet above ground level and prohibitions against night flights.  Additionally, the proposal fails to address privacy issues and the potential use of drones for surveillance activities on another person’s property.

The following provisions are the major components of the proposed rule, which would apply to unmanned aircraft weighing less than 55 pounds that are used for non-hobby and non-recreational purposes:

Operator Certification and Reporting

Certification.  An operator of a UAS must have an “unmanned aircraft operator certificate with a small UAS rating,” which requires:

• Meeting eligibility requirements:  the applicant is at least 17 years old, speaks English, has no state or federal drug offenses, has no physical or mental condition to prevent safe UAS operation, and the applicant’s identity is verified by the FAA.
• Passing an initial aeronautical knowledge test at an FAA-approved knowledge testing center, which covers: (1) applicable regulations relating to small UAS rating privileges, limitations, and flight operation; (2) airspace classification and operating requirements, obstacle clearance requirements, and flight restrictions affecting small UAS operation; (3) official sources of weather and effects of weather on small UAS performance; (4) small UAS loading and performance; (5) emergency procedures; (6) crew resource management; (7) radio communication procedures; (8) determining the performance of small UAS; (9) physiological effects of drugs and alcohol; (10) aeronautical decision-making and judgment; and (11) airport operations.
• Passing a recurrent aeronautical knowledge test every 24 months.

Reporting. An operator must report an accident to the FAA within 10 days of any operation that results in injury or property damage.

Aircraft Requirements

• Aircraft registration.   A small unmanned aircraft must be registered with the FAA.
• Markings.   A small unmanned aircraft must display nationality and registration markings.
• Aircraft condition.  An operator must maintain a small unmanned aircraft in a condition for safe operation.

Operation Requirements

Pre-flight requirements.  Before a flight, an operator must conduct a pre-flight inspection and assessment that includes:

• Inspection of the links between the unmanned aircraft and its control station.
• Verification of sufficient power to operate the aircraft at least 5 minutes beyond the intended operational time period.
• Assessment of the operating environment, including local weather conditions, local airspace and flight restrictions, locations of persons and property on the ground and other ground hazards.
• A briefing to all persons involved in the aircraft operation that addresses operating conditions, emergency procedures, contingency procedures, roles and responsibilities and potential hazards.

Visual line of sight requirement.  An operator must maintain a “visual line-of-sight” with the unmanned aircraft, using only human vision that is unaided by any device other than glasses or contact lenses.

Use of visual observer.   An operator may use “visual observers” to assist with the visual line-of-sight requirement.

• An operator and visual observer must maintain constant communication, which may be made through communication-assisted devices.
• The aircraft must still remain close enough to the operator for the operator to be capable of maintaining the visual line-of-sight.

Operating limitations.  An operator must not operate an unmanned aircraft:

• More than 500 feet above ground level.
• More than 100 mph.
• After daylight, which is the time between official sunrise and sunset.
• When there is not minimum weather visibility of 3 miles from the aircraft’s control station.
• No closer than 500 feet below and 2,000 feet horizontally away from any clouds.
• Over any persons not directly involved in the operation and not under a covered structure that would protect them from a falling UAS.
• From a moving aircraft or vehicle, unless the moving vehicle is on water.
• Within Class A airspace; or within Class B, C, or D airspace or certain Class E airspace designated for an airport, without prior authorization from the appropriate Air Traffic Control facility.
• Carelessly or recklessly, including by allowing an object to be dropped from the aircraft in a way that would endanger life or property.

“Micro” UAS

In the proposed rule, the FAA also presents the possibility of including regulations in the final rule for “micro-UAS,” or unmanned aircraft weighing no more than 4.4 pounds that are composed of  “frangible” materials that yield on impact and present minimal safety hazards.  The micro-UAS category would require operators to self-certify their familiarity with the aeronautical knowledge testing areas; would limit operation to:  1,500 feet within the visual line-of-sight of the operator, no more than 400 feet above ground, only in Class G (uncontrolled) airspace and at least 5 miles from an airport; and would allow flight over people not involved in the operation.  The agency invites comments on whether to include a micro-UAS category in the final rule.

What’s not in the Proposed Rule?

Privacy concerns.  Many in the agricultural community worry about the potential use of drones for surveillance activities that violate a property owner’s privacy.  The FAA states that privacy concerns about unmanned aircraft operations are beyond the scope of this rulemaking and that “state law and other legal protections for individual privacy may provide recourse for a person whose privacy may be affected through another person’s use of a UAS.” 

The agency also notes the recent Presidential Memorandum issued by President Obama, Promoting Economic Competitiveness While Safeguarding Privacy, Civil Rights, and Civil Liberties in Domestic Use of Unmanned Aircraft Systems (February 15, 2015), which requires the FAA to participate in a multi-stakeholder engagement process led by the National Telecommunications and Information Administration to develop a framework for privacy, accountability, and transparency issues concerning the commercial and private use of UAS in the NAS.   The memorandum also requires agencies to “ensure that policies are in place to prohibit the collection, use, retention, or dissemination of data in any manner that would violate the First Amendment or in any manner that would discriminate against persons based upon their ethnicity, race, gender, national origin, religion, sexual orientation, or gender identity, in violation of law.”  Read the Presidential Memorandum here.

External loads and towing operations.   The FAA declined to propose new regulations for small unmanned aircraft with towing and external load capabilities. Instead, the agency invites comments, with supporting documentation, on whether external load and towing UAS operations should be permitted and whether their use should require airworthiness certification, higher levels of airman certification or additional operational limitations.

What’s Next?

The FAA will accept public comments on the proposed small UAS rule until April 24, 2015.   Issuing a final rule could take at least another year after the comment period closes.  In the interim, FAA encourages operators to visit http://knowbeforeyoufly.org/ to understand current regulations for the use of small UAS, which remain in place until the FAA issues its final rule.

The proposed small UAS rule is available in the Federal Register online here.  To submit comments for the rule, Docket No. FAA–2015–0150, visit www.regulations.gov.

Author: LARRY R. GEARHARDT, OSU EXTENSION FIELD SPECIALIST IN TAXATION

Generally, a taxpayer that buys business or income-producing property (not held for sale) with a useful life of more than one year cannot deduct its full cost as an expense for that year. However, the Internal Revenue Code (Code) allows an annual deduction of a portion of the cost of the property. This deduction may be a deduction for depreciation, amortization or depletion.

For most tangible property, a depreciation deduction is provided under the Modified Accelerated Cost Recovery System (MACRS). IRS form 4562 is used to claim the deduction for depreciation.

SECTION 179 EXPENSE DEDUCTION AND ACCELERATED FIRST YEAR DEPRECIATION (AFYD)

There are two exceptions to the aforementioned rule. The first exception is the section 179 expense deduction and the other exception is the Accelerated First Year Depreciation (AFYD). Many taxpayers are eligible to deduct (in lieu of depreciation) the cost of most tangible personal property used in the active conduct of a trade or business pursuant to section 179 of the Code. The taxpayer can elect on Form 4562 to expense the cost of “eligible 179 property” in the year that the property was placed in service. “Eligible property” that qualifies for section 179 includes: machinery and equipment; property contained in or attached to a building (other than structural components), such as milk tanks, automatic feeders, barn cleaners, and office equipment; livestock, including horses, cattle, hogs, sheep, goats, mink and other fur-bearing animals; grain bins; single-purpose agricultural or horticultural structures; and agricultural fences and drainage tile. This deduction can be used for both new and used property.

In addition to, or in combination with, the section 179 expense deduction, taxpayers were allowed to deduct 50% of the cost of “qualified property” in the year that the property was placed in service as accelerated depreciation. “Qualified property” is tangible personal property that qualifies to be depreciated under the MACRS depreciation method with a recovery period of twenty years or less. This deduction can only be used when purchasing new property and the taxpayer must be the original user of the property.

RECENT HISTORY OF SECTION 179 AND AFYD

In 2013, the section 179 expense deduction was $500,000 per item, with a threshold of $2,000,000 before the deduction was limited. The AFYD limitation was 50% of the cost of the eligible property. However, these two deductions expired at the end of 2013 along with 53 other tax credits, deductions, and tax benefits. Beginning in 2014, the section 179 expense deduction dropped to $25,000 and the AFYD was eliminated entirely.

Prior to the end of 2013, a tax extender bill was introduced in Congress to extend the expired tax deductions, including the section 179 expense deduction at $500,000 and AFYD at 50%. The tax extender bill did not pass prior to the end of 2013 due to the inaction of Congress. So beginning in 2014, the section 179 expense deduction was $25,000 and there was no AFYD.

Congress debated the tax extender bill throughout most of 2014. Reports from Washington DC indicated that the tax extender bill would pass, but when? Finally, in December, Congress passed the tax extender bill which returned the section 179 expense deduction to $500,000 and AFYD to 50%. President Obama signed the bill on December 19, 2014. It is important to note that the bill extended the beneficial tax provisions only through 2014. Beginning in 2015, the section 179 expense deduction reverted back to $25,000 and AFYD was eliminated.

FARMERS IN A QUANDARY

Congress’ inaction regarding the tax extender bill in 2013, and continuing through most of 2014, put farmers in a quandary. The farmers had to decide whether or not to make capital expenditures in 2014 and rely on the tax extender bill being passed, or not to make the purchases. As a result of this quandary, some farmers resorted to creative purchase arrangements where they called the purchase a “lease.” Others entered into agreements where the purchase agreement contained an option to “lease” or “purchase,” thereby allowing them the opportunity to take advantage of the section 179 expense deduction if the tax extender bill was passed. However, in many instances, the “lease” would not pass IRS scrutiny. The so-called lease was really a conditional sales agreement which would have received different tax treatment which was less beneficial. With the passage of the tax extender bill in December of 2014, the issue was resolved so the legitimacy of the leases never came into question.

Since the $500,000 section 179 expense deduction and the AFYD expired at the end of 2014, farmers are put in the same quandary in 2015 that they had in 2014. Should farmers make that capital expenditure in 2015 and count on Congress extending section 179 at $500,000 and continue AFYD? Does a lease of equipment, rather than a purchase, receive favorable tax treatment?

 A lease is a viable alternative as long as the lease is a legitimate lease. This document examines the requirements of a true lease for tax purposes and the factors that turn the lease into a conditional sales agreement.

TAX TREATMENT OF A LEASE

If you pay to use property that you do not own in business, the payments are “lease payments.” These lease payments paid for property used in business are deductible business expenses. On a Schedule F tax form, the payments would be deducted on line 24a.

A “lessor” is the person who owns the property and allows another to use the property in exchange for payments. A “lessee” is the person using the property and making payments in exchange for the use of the property.

Before trying to understand the tax advantages of leasing, it is important to understand the different types of leases. For IRS purposes, equipment leases generally fall into two categories, each with a different type of purchase option:

1. Non Tax-Oriented Leases: Legal ownership resides with the lessor, however, because the lessor is not considered to be at risk at the end of the lease, the lessee receives the tax benefits of ownership. In other words, the lease acts merely as security for a sale.
2. Tax-Oriented True Leases: Lessor maintains ownership of the equipment and there is a fair market value purchase option for lessee at the end of the lease.

When leases are structured as true leases, the lessee may claim the entire lease payment as a deductible business expense.

CONDITIONAL SALES AGREEMENT

If an agreement is found to be a conditional sales agreement, payments made pursuant to the agreement are non-deductible purchase payments. An agreement is treated as a conditional sales agreement if it provides that you will acquire title to, or equity in, the equipment upon completing a certain number or amount of payments. Being the “owner” of the equipment is a prerequisite to taking the section 179 expense deduction and depreciation. An “owner” is the person that has the benefits and burdens of ownership and not necessarily the owner of legal title. Therefore, if the purchaser is not considered the “owner,” a conditional sales agreement may be the worst of two worlds – no business expense deduction for the payments and no depreciation deduction.

DISTINGUISHING A LEASE FROM A CONDITIONAL SALES AGREEMENT

The intent of the parties controls whether an agreement is a lease or a conditional sales agreement. How do the parties view the transaction? While the intent of the parties is important, for tax purposes the intent of the parties may be inferred from certain objective factors.

A conditional sales agreement (and not a lease) exists if any of the following are found:

1. The agreement applies part of each payment toward an equity interest.
2. The agreement provides for the transfer of title after payment of a stated amount.
3. The amount of the payment to use the property for a short time is a large amount of the amount paid to obtain title to the property.
4. The payments exceed the current fair rental value of the property (based upon comparisons with other similar properties).
5. There is an option to buy the property at a nominal price as compared to the property’s value at the time the option can be exercised.
6. There is an option to buy the property at a nominal price as compared with the total amount required to be paid under the agreement.
7. The agreement designates a part of the payments as interest, or in some way makes part of the payments easily recognizable as interest.

CONCLUSION

For lease payments to be deductible as a business expense, the lease agreement must be a Tax-Oriented True Lease. If there are any factors present that show that the payments are intended to be creating equity in the equipment, the agreement will be deemed to be a conditional sales agreement. The payments pursuant to a conditional sales agreement are not deductible business expenses and the equipment is not depreciable unless the purchaser is considered the owner.

The importance of this issue depends on when Congress addresses the section 179 expense deduction and AFYD. If Congress’ inaction in 2013 and 2014 is any indication, farmers may very well find themselves in the same position of not knowing whether or not to make capital expenditures in 2015. The best possible scenario would be for Congress to permanently establish section 179 at $500,000 and AFYD at 50% to provide farmers with the certainty that they need to make wise business decisions. However, this is unlikely to happen. If a lease is a viable alternative for the farmer, make sure that it is a Tax-Oriented True Lease.

Resources: 2015 RIA Federal Tax Handbook, (Thomson-Reuters Checkpoint), sec. 1900, 1941

                   2014 IRS Publication 225, Farmers Tax Guide, p. 22

                   2014 IRS Publication 535, Business Expenses, p. 9

House Committee Sets Out to Address Water Quality

The 131st session of the Ohio General Assembly is underway with a few changes to the structure and leadership of the committees that address agriculture.  In the House of Representatives, the previous Agriculture and Natural Resources Committee has been renamed as the Agriculture and Rural Development Committee.  Natural resource issues, previously handled with agriculture under the old committee structure, will now go to a newly formed Energy and Natural Resources Committee.  The committee modifications echo similar changes made last session in the Senate.

Brian Hill (R-Zanesville) will serve as the new chair of the House Agriculture and Rural Development Committee, with Tony Burkley (R-Payne) as vice chair and John Patterson (D-Jefferson) as the ranking minority member.  Other committee members are Terry Boose (R-Clarksville), Jim Buchy (R-Greenville), Jack Cera (D-Bellaire), Christina Hagan (R-Marlboro Township), Steve Kraus (R-Sandusky), Sarah LaTourette (R-Bainbridge Township), Michael O’Brien (D-Warren), Sean J. O’Brien (D-Bazetta), Bill Patmon (D-Cleveland), Debbie Phillips (D-Albany), Wes Retherford (R-Hamilton ), Jeff Rezabek (R-Clayton), Margaret Ann Ruhl (R-Mt. Vernon), Tim Schaffer (R-Lancaster), Michael Sheehy (D-Oregon), Andy Thompson (R-Marietta), A. Nino Vitale (R-Urbana) and Paul Zeltwanger (R-Mason).

The House Agriculture and Rural Development committee will kick off its work with a prominent issue:  water quality.  Speaker Cliff Rosenberger has stated that water quality will be a priority issue that the House "needs to address and address quickly."  Late last session, the House attemped to mitigate algal issues in Ohio lakes by passing legislation that would have affected applications of livestock manure and chemical fertilizers (HB 490).  The legislation failed to pass the Ohio Senate and expired on December 31, 2014 with the end of the legislative session.  This week, the House Agriculture and Rural Development Committee will revisit those issues when it meets off-site for a hearing at Cooper Farms in Van Wert to discuss water quality, nutrient management and agriculture.  Expert witnesses in agriculture and watershed management will present testimony and address questions from the committee.

On the Senate side of the new legislative session, the Senate Agriculture Committee will continue under the leadership of Cliff Hite (R-Findlay), with vice chair Joe Uecker ((R–Miami Township) and ranking minority leader Lou Gentile (D-Steubenville).  Other committee members are Bill Beagle (R–Tipp City), Dave Burke (R-Marysville), Capri S. Cafaro (D-Hubbard), Randy Gardner (R-Bowling Green), Gayle Manning (R-North Ridgeville), Bob Peterson (R-Sabina) and Michael J. Skindell (D-Lakewood).  The Senate Agriculture Committee does not currently have any hearings on its schedule.

Attorney Bill Bridgforth will present OSU's next webinar on "The 2014 Farm Bill:  Guiding a Client through the New Law" on Friday, January 9 at 1 pm EST.  Bridgforth is a senior partner in the Arkansas law firm of Ramsay, Bridgforth, Robinson & Raley, LLP who represents agricultural producers around the United States.  He will explain the election decisions producers and landowners must make under the new Farm Bill and will provide examples of decision making impacts. 

There is no registration or fee required for the webinar, which is accessible at https://carmenconnect.osu.edu.  A recording of the webinar and a listing of additional webinars is available at farmoffice.osu.edu.  

The Ohio Food, Agriculture & Environmental Law Webinar Series is an outreach project of OSU Extension's Agricultural & Resource Law Program.