Depreciation Allowed for Cannabis and CBD Companies on 2020 Tax Returns

CannaBlog by Jim Marty, CEO, and Calvin Shannon, Principal

Bridge West CPAs and Advisors to the Cannabis Industry

Cannabis Businesses Depreciation Deductions

How much depreciation is allowed for cannabis companies? The answer depends on several factors.

  • For retail cannabis companies, the answer is most likely zero with the exception of equipment that is used for safe storage and packaging.
  • For cultivation and extraction facilities, depreciation is allowed, but it is limited.
  • For CBD companies, the same amount of depreciation is allowed as any other taxable entity.

Internal Revenue Service (IRS) code section 280E prevents cannabis companies from taking any deductions, including depreciation. However, 280E allows taxpayers to reduce gross receipts by cost of goods sold (COGS) when calculating taxable income. Any costs, including depreciation attributable to the production and maintenance of inventory, can be capitalized to inventory. Then the costs can be included as part of COGS when the inventory costs are attributed to being sold.

The Office of Chief Counsel IRS Memorandum Number 201504011 points to §1.471-11(c)(2)(iii). In summary, depreciation related to necessary assets and incident to inventory production would be allowable as an inventoriable cost to the extent the depreciation is reflected as an inventoried cost in the taxpayers’ financial reports, internal books, and records, and is consistent with Generally Accepted Accounting Principles (GAAP.)

For retail cannabis stores, depreciation of leasehold improvements, cash registers, and other assets, i.e., display cases, would be considered selling expenses under 280E. As for selling expenses that are not part of inventoriable costs, depreciation expenses would not be deductible. However, it may be reasonable to characterize depreciation from assets used to secure inventory, such as safes and vaults, as inventoriable costs.

For cultivators and extractors, depreciation is part of COGS, so it is allowed. Much of the depreciable assets used by production companies, such as cultivators and processors, would be necessary to produce inventory. Accordingly, the depreciation from these assets could be inventoried and included as COGS.

The timing of the depreciation deduction is slower for cannabis businesses compared to traditional companies. The IRS provided guidance on methods of depreciation for cannabis companies in Memorandum 201504011.

The timing of the depreciation deduction is slower for cannabis businesses compared to traditional companies. he IRS issued Memorandum 201504011 in January 2015 to provide guidance on methods of depreciation for cannabis companies. This Memorandum suggests that taxpayers turn to the regulations under IRS code section 471, which allows for depreciation under GAAP. It is essential to point out that accelerated approaches to recognizing depreciation, such as bonus depreciation and section 179, would not be consistent with GAAP and are disallowed for taxpayers subject to 280E.

For 2020 tax returns, immediate expensing of capital assets under IRC Bonus Depreciation rules is allowed for companies operating outside of the cannabis industry.

At this time, CBD companies are taxed as non-cannabis companies, so these accelerated depreciation methods are allowed. Whether the IRS will go along with this in an audit situation remains to be seen.

As you can see from the chart below, the type of cannabis business you are operating can significantly affect the amount of depreciation you can deduct.

Can a better result come from using different companies like a management company or an IP company?  The answer is no.  The IRS will review how businesses use their equipment to determine if restrictions on deprecation apply, not who owns it.

Bridge West will continue to follow the new 2021 U.S. Congress and will share updates regarding any changes to the amount of depreciation allowed for cannabis businesses. Since 2009, our team of experienced accounting and tax advisors has been serving cannabis businesses nationwide, and we serve over 400 license holders. If you have any questions or to schedule a complimentary consultation, please contact us.