With decreasing commodity prices, many farmers are looking for ways to raise cash and pay down debt. One strategy that is often considered involves selling farm assets that are no longer used (or have become unproductive).
Before you start selling those unneeded items, it is important to understand what kind of tax liability will arise from the sale of farm assets. In this article, I’ll share four steps to consider before you sell farm equipment or land.
1. Understand your tax basic
Before selling a piece of farm equipment or property, you must first understand your tax basis. Many farmers incorrectly assume that tax basis is what you paid for an asset. That is not necessarily the case.
For land, tax basis is what you paid for the land (or what it was worth when you inherited it). To this you can add any improvements you’ve made that were not deducted on your prior tax returns.
For buildings and equipment, it is the original cost or basis less any depreciation that was written off in prior years. For raised livestock, the tax basis is usually zero unless previous costs in raising were forgone (which is not usually done).
2. Estimate your potential gain
Once you have the tax basis, you can calculate what the gain is by subtracting the basis from the sales price (less the cost of selling the asset). This would include the cost of getting the farm property ready to sell – but be careful, you cannot deduct such costs on the sale while also deducting them against income as repairs.
It is important to note that if some of the proceeds are used to pay off debt associated with the asset, that does not affect the gain calculation. Even if it takes all the money received to pay off the debt, you could still have realized gain. If you let the piece of property go back to satisfy the debt, the amount of debt that is eliminated is the same as the sales price.
3. Decide how to classify the sale
Once you have calculated the gain, you must determine if it is taxed at ordinary income tax rates or a possibly lower capital gains tax rate. Ordinary income is taxed just like wages and interest income.
If you have previously taken a depreciation deduction, then all or part of your realized gain will be taxed as ordinary income. If you sell the asset for more than what you originally paid for it, that part of the gain is taxed as a section 1231 gain. It is taxed as a capital gain along with any undepreciated basis.
4. Know the traps to avoid
As with any tax-related event, there are some traps to know and avoid. One of the most commonly overlooked traps involves alternative minimum tax. For example, if your capital gain is large, you may have to pay more than the capital gains rate by becoming subject to alternative minimum tax.
Talk to a qualified CPA to determine if your transaction meets such criteria.
Another trap involves selling equipment on an installment contract sale. In this situation, all of the prior accelerated depreciation must be added to ordinary income in the year of sale – even if no cash was collected. Some farmers overlook this.
You must also be aware that gains from the sale of assets count against you for calculation of an earned income credit and the premium tax credit for the Affordable Care Act. Healthcare is increasingly complex for farmers, and the sale of assets can further complicate matters.
A final thought
Gains can be deferred and not affect your tax liability. That is, of course, if you trade the assets for like-kind property. However, if you take the cash or the equipment dealer sells it for you, you will have to treat it as a sale.
In conclusion, if you are selling property or equipment, keep in mind that if you have a gain, it may be considered as income. Contact your tax adviser for more information on properly filing this type of income adjustment.
Readers should not act upon the presented content or information without first seeking appropriate professional advice.
