In farming, it's certainly not an uncommon practice to purchase new equipment in order to save on taxes. Unfortunately, this year the predilection to write off those shiny new tractors, planters and combines might come back to haunt the industry, says Paul Neiffer, The Farm CPA.
Four strong years of income, coupled with the opportunity to accelerate depreciation, led some farmers to buy more equipment than they needed. Under Section 179, farmers could buy up to $500,000 in equipment and depreciate it immediately.
Neiffer explains in the following video:
"The problem is that a lot of that equipment has been financed over five or seven years," says Neiffer. Although farmers might have a tiny interest rate on the loan, they could still have to make a $100,000 principal payment on a new combine.
This year, farmers who bought equipment just to save on taxes could get hit with a double whammy. Without the benefit of a deduction to claim, they could wind up paying taxes on $100,000 more income than the previous year. "Section 179 is nice in the beginning, but it eventually catches up with you," says Neiffer.
Although the House passed legislation extending Section 179 tax benefits—expensing levels dropped to $25,000 in January—the Obama Administration opposes the extension without a corresponding revenue offset. In Neiffer’s mind, that dooms passage of an extension until after the mid-term election, when it might be too late to make an informed equipment purchase decision.
"I tell farmers that Section 179 for 2014 is basically zero," says Neiffer, who recently met with a farmer client who bought a new tractor the year before just to save on taxes. The farmer boasted to him that "we never even use it."
Moral of the story: Never buy equipment just to save on taxes. Buy it to improve your operation and bolster cash flow. "Then it makes sense to take advantage of the tax benefits," Neiffer says.
Buying non-essential equipment, much like prepaying too much grain expense, soaks up working capital that could be used to buy additional farmland, invest in a retirement plan (which in many cases can produce a tax deduction just as good as the one for buying equipment) or invest in higher-yielding outside financial assets. "Farmers focus too much on the farm and forget other financial assets," he says.
"The problem is that you can’t drive it. You can’t show off to your neighbor," Neiffer says. "But 30 years down the road, when that combine that you paid $300,000 for is now worth $10,000, that retirement plan that you put $300,000 into over a 30-year period may be worth $3 million."