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The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

It Might Not Pay to Do Equipment Trade-in

Dec 06, 2011

Most farmers automatically assume that it is always better to trade-in their farm equipment to save on income taxes.  However, for 2011, if your total farm equipment purchases is going to be less than $500,000, then in most cases it would almost always be better to sell your farm equipment for cash and then buy equipment for full face value from a tax standpoint.  I will explain here, however, in many states (such as Washington), you are not subject to sales or use tax on the trade-in value.  In these states, the savings on not paying sales tax may outweigh the income tax savings.  You would need to review this in each situation.

Let's say we have a farmer who is self-employed and has earned $100,000 for the year and has a tractor currently worth $100,000.  The tractor is fully depreciated.  The farmer can trade it in for a tractor costing $100,000 or he can sell the tractor for $100,000 and use these proceeds to purchase the newer tractor.  If the farmer trades the tractor in, he recognizes no gain on the tractor and has no additional depreciation to take.  If he sells the tractor for $100,000, he recognizes a gain of $100,000 on form 4797 and he can take Section 179 or bonus depreciation, if a new tractor, of $100,000 on his Schedule F to bring the net bottom line income back to the same as the trade-in. 
 
Now most farmers are asking "What's the difference"?  The difference is that with the sale of the tractor, this income is not subject to self-employment tax.  If the farmer had made $100,000 on his schedule F, he has now converted this income to $100,000 on form 4797 and zero income on Schedule F.  During normal years, the self-employment tax savings would be close to $15,000 (in 2011, it would be about $2,000 less).  All the farmer has done is move $100,000 of income from Schedule F to Form 4797 and save about $15,000 in self-employment taxes.
 
If the farm is operated inside of a corporation (either C or S), there would be no material tax savings.  This really only applies to a sole proprietor or partnership where the farmer would be under the maximum self-employment base of approximately $107,000.  If the farmer exceeds this amount of net self-employment income, then the savings would be slightly less than 3% of the trade-in value.
 
Also, remember that the sales tax cost may outweigh the income tax savings, so you must review this with your tax advisor to see if it applies to your situation.
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