Agriculture & Natural Resources
Tax Law Changes for Trade-Ins
In the past, personal property that farmers used as a trade-in on a purchased item was treated as a “like kind” exchange. The Tax Cuts and Jobs Act changed the wording to accommodate only real property as eligible for like kind exchanges. Starting in 2018, we will have to treat personal property, such as equipment and livestock, as being sold when a trade occurs.
This could potentially have both good and bad consequences. For example, let’s say you have Tractor A that you plan on purchasing. The full cost of Tractor A is $150,000. You are going to trade in Tractor Z and the trade allowance is $70,000. Under the old law, you would not report the sale of Tractor Z, it would continue to depreciate out and be marked as a traded item on your asset schedule. Meanwhile, you would put Tractor A on your depreciation schedule with a cost basis of $80,000 ($150,000-70,000).
Under the new law, you’ll have to report Tractor Z as sold for $70,000. If there is any cost left to depreciate, that will reduce the amount of gain or recapture on Tractor Z. You’ll have to put Tractor A on the depreciation schedule at $150,000 cost basis. Farmers report the sale of equipment and livestock on Form 4797 of their income tax return. The farmer generally reports the gain as recaptured depreciation, which is taxed at ordinary income tax rates or capital gain, which is taxed at capital gain rates. Neither of those are subject to self-employment tax.
Let’s assume Tractor Z was depreciated out, you would report the entire sales price of $70,000 on the Form 4797, under the new law. The entire cost of $150,000 of Tractor A is available for depreciation on your Schedule F (farm income and expenses).
Most likely, you’ll use some combination of depreciation allowances like Section 179 and/or Bonus Depreciation to get the Schedule F to the net amount you prefer. Keep in mind the goal of tax planning is not to avoid taxes, rather to be consistent in the income tax brackets and to avoid large swings in income levels from one year to the next.
Continuing the example above, let’s assume you have no other means of income and generally keep the amount of adjusted gross income in the area of $75,000. The gain on the sale of the tractor was $70,000 on the Form 4797. Ideally, you then have a Schedule F net income of $5,000 to be consistent on the overall amount of adjusted gross income. Remember, self-employment tax is only on earned income such as the Schedule F and not Form 4797.
On the positive side, taxpayers could pay less in self-employment tax than they have in previous years. In our example, you’re paying self-employment tax on $5,000 rather than $75,000. The flip side of that argument is that taxpayers need to remember that paying less or zero amounts of self-employment tax could have a negative impact of future retirement earnings or even qualified quarters for disability payments.
Another factor to consider is the difference between federal and state depreciation laws. Kentucky has limited the Section 179 deduction to $25,000, and the deduction gets phased out if equipment purchases are greater than $225,000. Kentucky also does not allow for bonus depreciation. This means likely substantial differences in gain between the Kentucky and federal income tax returns. You need to let your tax preparers know when you have traded items and how much was allowed on the trade. As always, it’s a good idea to plan ahead and visit with your tax preparer before the end of the year to avoid any surprises when it’s time to file your returns.
Source: Suzy Martin, UK Farm Business Management