Equipment Trade-Ins (Continued)

• January 30, 2018
• Paul Neiffer

As discussed in yesterday’s post, trading in farm equipment has become much more complicated.  Under the old law, the tax code required you to defer and roll over the trade gain into the new equipment and reduce the value by this amount.  The cost basis of the asset traded-in (if any) was added to the cash or boot paid for the new piece of farm equipment.  You could not take Section 179 on the old asset’s basis, but you could take 50% bonus depreciation on it.

Here is an example of the old law:

Farmer Jones has a combine worth $200,000 that still has a cost basis of $100,000.  He trades it in on a new combine worth $500,000.  His tax cost basis in the new combine is now $400,000 ($300,000 cash paid plus $100,000 cost basis from old combine).  He can only take Section 179 of up to $300,000 on the new combine but can take 50% bonus depreciation on all $400,000 if no Section 179 was taken.  Any remaining basis is then depreciated over 7 years.

Now the new law changes this.  The farmer is now required to report the trade-in value as the sales price.  This will usually result in a gain on sale for federal income tax purposes since most farm equipment has been fully depreciated over the last few years using Section 179 or bonus depreciation.  However, the cost basis of the new equipment is now the full price.

In our example above, the farmer would recognize a gain of $100,000 ($200,000-$100,000 cost basis) on the traded-in combine.  He then fully depreciates the new combine and writes-off $500,000 in the current year.

However, here is where it can get more complicated.  Since NOL’s can only offset 80% of taxable income starting in 2018, the farmer may want to elect out of 100% bonus depreciation on the combine and only use enough Section 179 to get his taxable income down to the correct number.

Again, using our example.   Assume Farmer Jones wants to report $200,000 of taxable income.  If he fully depreciates the combine, his income is zero.  Therefore, he can elect out of bonus depreciation and use Section 179 to get his income down to $200,000 and have $300,000 or so of basis that he can depreciate over the next 5-7 years.  5 if new and 7 if the combine is used.

One other problem area that really may start to show its head is Section 1245 recapture on the sale.  Many farmers have done equipment exchanges year-after-year and in many cases, the total cost of the new combine never shows up on the depreciation schedule which may cause some of the gain on the trade-in to be treated as Section 1231 gain when in reality it is actually Section 1245 ordinary income recapture.  Since all trades will now have to be reported as a sale, this will likely happen.

As an example, assume a combine was purchased in 2017 for $500,000 but had a trade that reduced the tax “cost” basis to $100,000.  The farmer then took Section 179 of $100,000 and brought the tax basis down to zero.  The combine is then traded in for a new combine in 2018 with a value of $400,000.  If the combine is only shown on the depreciation schedule as “original” cost of $100,000, many tax preparers would show an ordinary gain of $100,000 and Section 1231 capital gain of $300,000.  The correct number is $400,000 of Section 1245 since the combine trade value was less than its original cost of $500,000.  You can only have Section 1231 gains on the excess of actual original cost of equipment or asset purchased.

As you can see, trades will be tougher to deal with starting this year.  We will keep you posted with the changes.

, Farm Industry Trends, Farm Taxes | 12 Comments »