Depreciation Allowed for Cannabis Companies on Tax Returns
How much depreciation is allowed for cannabis companies? The answer depends on several factors:
- For retail cannabis companies, depreciation is generally not allowed, with potentially some small exceptions
- For cultivation and extraction facilities, limited depreciation is allowed
Understanding the complexities of depreciation for cannabis companies is critical, as the permitted amount is contingent on several key factors. The intricacies stem from stringent Internal Revenue Service (IRS) regulations, particularly code §280E, which severely limits the deductions cannabis-related businesses can claim. Here’s a breakdown of what you need to know:
Retail Cannabis Ventures: Typically, these businesses are precluded from claiming depreciation, save for a few minor exceptions. This is mainly due to §280E, which prohibits deductions for any business involved in the trafficking of controlled substances, cannabis included.
Cultivation and Extraction Operations: These sectors see slightly more leniency, with a limited scope for depreciation claims. Essential to this process is understanding the IRS Office of Chief Counsel Memorandum 201504011, which outlines that depreciation directly related to inventory production can be considered as part of the cost of goods sold (COGS), but only if it’s consistently reflected in financial reporting adhering to Generally Accepted Accounting Principles (GAAP).
The Intricacies of §280E: For retail stores, this means typical assets like leasehold improvements and equipment can’t be depreciated as they’re categorized as non-deductible under the stringent §280E guidelines. Cannabis businesses face slower depreciation schedules compared to their non-cannabis counterparts, with immediate capital asset expensing and accelerated methods like bonus depreciation being off the table. Section 179 rules are allowed, but for cannabis companies, the timing is more complex.
The legal landscape, too, is evolving. Recent court rulings, such as the 2022 Lord v. Commissioner case, have further clarified the limitations, emphasizing the non-availability of §167 deductions for businesses dealing with controlled substances. Similarly, the 2021 San Jose Wellness case underscored the IRS’s vigilance in monitoring improper deductions by cannabis enterprises.
Lord v. Commissioner (2022): This case is a pivotal moment for understanding the limits of depreciation for cannabis businesses. The court examined the application of §168K, which pertains to bonus depreciation, in the context of a cannabis business. The Lords, who ran a cannabis operation, faced significant tax liabilities and penalties after the court determined that §168 depreciation methods, which include §167 depreciation deductions, were not available to their business. This is because §167 deductions are expressly prohibited for businesses dealing with controlled substances under federal law. The ruling underscored the harsh tax reality facing cannabis businesses, as the federal government continues to classify cannabis as a controlled substance, irrespective of state legalization efforts.
San Jose Wellness v. Commissioner (2021): This case further illustrates the intense scrutiny the IRS places on cannabis companies regarding tax deductions. San Jose Wellness, a cannabis dispensary, attempted to claim significant deductions, some of which they believed were charitable contributions. However, the court ruled that these were not charitable contributions but rather business expenses related to the trafficking of a controlled substance, which are not deductible under §280E. This case is particularly instructive for cannabis businesses on the importance of understanding what constitutes a legitimate deduction and the risks of aggressive tax strategies. It emphasizes the need for cannabis businesses to be exceedingly cautious and consult with tax professionals well-versed in the unique challenges of the industry.
The Way Forward
Calvin Shannon and the cannabis team at BGM have significant experience helping clients navigate the complex and ever-changing tax terrain of the cannabis industry. Calvin commented, “Understanding depreciation for cannabis companies is a critical aspect of tax strategy, requiring a deep knowledge of the regulations and a vigilant approach to compliance. Navigating this landscape is essential for the financial health and profitability of any cannabis business.”
At BGM, we specialize in providing accounting, tax, advisory services, and regulatory compliance tailored to the cannabis industry. Our dedicated cannabis team is committed to guiding cannabis businesses through these challenges, helping to maximize financial opportunities while ensuring full compliance with existing laws.
For those interested in exploring strategies to address depreciation challenges and optimize tax strategies within the cannabis industry, contact us. Together, let’s cultivate success in this dynamic and challenging marketplace.