State Tax Treatment of Farm Equipment Trades
Under old tax law, a farmer could trade-in farm equipment and recognize no gain or loss on the trade. For example, assume a farmer has an old combine worth $200,000 and trades it in for a new combine worth $500,000. The $200,000 trade value is essentially ignored and the tax cost basis of the new combine is simply $300,000 (the net cash paid).
However, the new tax law does not allow tax free trades on farm equipment. In our example, the farmer will recognize a sale on the old combine of $200,000 (likely all gain) and then on the new combine, the tax cost basis will now be $500,000 which is allowed be deducted 100% until December 31, 2022. After that date bonus depreciation drops by 20% each year, therefore, beginning in 2027, the farmer will have to report 100% of the gain on the trade and may be only to deduct the new combine using either Section 179 (of a $1 million) or regular depreciation.
For farmers in a state without state income taxes, this new provision can save some taxes (at least until 2023). The gain on the trade is not subject to self-employment taxes and the deduction on the new combine reduces self-employment taxes.
However, many states have restrictions on the amount of Section 179 or bonus depreciation that can be taken. Many of the key farm states limit Section 179 to $25,000 or have an add-back of some percentage of the excess over $25,000. Here is a list of those states:
- Minnesota – Add back 80% of Section 179 in excess of $25,000
- New Jersey
- Ohio – Have to add back certain percentages in excess of $25,000
Almost all of the key Ag states do not allow bonus depreciation. The ones that allow bonus depreciation the same as federal are as follows:
- New Mexico
- North Dakota
- West Virginia
The general assumption is that for those states with no bonus depreciation and limited Section 179, the elimination of the trade-in provisions will always result in extra tax. However, in many situations the “sale” will actually now result in a tax loss in those states. Although the farmer may recognize a loss on the sale, the farmer will have lower depreciation on the new asset so likely the bottom line is an overall increase in state taxable income versus federal taxable income for the year of trade. Let’s look at our example:
Assume the farmer purchased the combine in 2015 for $400,000 and depreciated it over 7 years. The deduction for 2015-2017 is $119,387.75. The combine is traded in 2018 so the depreciation deduction for the current year is $30,065.60 resulting in accumulated deprecation of $149,453.35. The combine now has adjusted tax cost basis of $250,546.65 and the selling price is now $200,000 resulting in a state tax loss of $50,546.65. On the new combine, the farmer can only deduct $100,000 (assuming the state conforms to the new 5 year 200db method for farm equipment). Therefore, under federal rules, the farmer reported gain of $200,000 and a deduction of $500,000 for a net deduction of $300,000. In the state, the farmer reported a loss on sale of $50,546.65 and deducted $100,000 for a net deduction of $150.546.65. The farmer gained a net deduction of about $150,000 on the federal return. However, the farmer will continue to write off $400,000 against its net state income over the next five years.
Now, some states such as Minnesota and Ohio have interesting adjustments and in certain situations the farmer may lose the benefit of this deduction, but for most other states, this is how it would work.
The bottom line is that state taxable income will still likely to be much higher for farmers who trade-in farm equipment than federal taxable income.