Take advantage of Section 179 and bonus depreciation allowances on equipment
For most crop producers, 2013 won’t be the highest taxable income year ever, but it will be up there. That means if you haven’t already done so, now might be the time to pull the trigger on equipment purchases the farm needs to be more efficient and profitable.
Bonus depreciation of 50% is in play for 2013, but it is scheduled to disappear Dec. 31. "You can deduct 50% with no limit," says Paul Neiffer, a CPA at CliftonLarsonAllen in Yakima, Wash. "This not only covers new equipment, but any new farm asset," Neiffer says. "For 2014, it’s zero, unless Congress reinstates it."
Equally important, Section 179 of the IRS code allows a deduction of $500,000 for 2013, which is set to change to $25,000 in 2014. Unlike bonus depreciation, Section 179 applies to new and used assets, such as equipment, grain bins and tiling.
"There might be better buys ahead ... Buying new or used equipment becomes very emotional."—Greg Peterson
If you purchase $1 million worth of new equipment in 2013, you can deduct 50% with Section 179, plus bonus depreciation for 50% on the remaining $500,000. The remaining $250,000 must be depreciated during the standard multi-year depreciation schedule, explains Mark Olson, CPA with Conway, Deuth & Schmiesing in Willmar, Minn.
It’s important to note that the Section 179 deduction must be used prior to bonus depreciation. Olson explains that in his example, the farmer cannot take $500,000 in bonus depreciation first and then $500,000 in Section 179 to deduct the entire $1 million in 2013.
One important question for producers who need equipment is whether to buy new or used. The answer depends on each producer’s circumstances and the price of each, Neiffer says. For example, one of his Iowa clients purchased a new tractor this spring, on which he has put quite a few hours. His dealer just offered him the opportunity to trade for a new tractor for just $9,000.
"That means his cost was only $11 per hour," Neiffer says, noting that buying new made the most economic sense. "If there was a $200,000 spread between new and used, he would have been better off with used."
New or Used? One crucial point is the relationship between the used equipment market and metal bought off the showroom floor.
"In each of the past 11 years, the used equipment index has shot up during the fourth quarter," says Greg Peterson, who tracks the equipment market and is Farm Journal Media’s used equipment expert. "There has been a big market crescendo at the end of the year." Much of this is due to recent tax policy, Peterson says.
This year, the market continues to be red hot and tight. Peterson says the market’s strength is a result of several factors, including a 60% drop in the average number of farm auctions this year compared to 2000 to 2005, increased farm income, a 6% to 8% yearly increase in the price of new equipment and the availability of fast tax write-offs.
Arguments can be made for buying new or used. It’s all about personal preference, how much debt producers are comfortable with and price spreads. For example, dealers are more aggressive in offering multi-unit deals. They will go to producers and say, "I’ll take these three pieces if you buy three or four new pieces," Peterson explains.
The discounts can be significant, and when combined with the tax advantages, there’s strong incentive to buy new, he adds.
Overall, Peterson looks for the used equipment market to remain strong through the end of the year. However, large combines might be softening—there are more of them showing up on dealer lots. "There’s a possible buying opportunity," he says.
For tractors, it’s just the opposite. For example, say you are looking for a good used 150 horsepower tractor. "The dealer already has three guys who want it," Peterson says.
Opportunities Ahead. While tax consequences are huge and the loss of most of Section 179 and all of bonus depreciation are significant, there might be economic reasons for waiting until next year to purchase equipment, Peterson says.
It’s possible that the loss of rapid tax write-offs combined with lower crop prices in 2014 could push used equipment prices down, he explains. A changing of the tides could be coming when we go from demand exceeding supply to supply exceeding demand. "There might be better buys ahead," he says.
One trend Peterson has noticed is a high demand and relatively high prices for equipment eight years and older. Enough producers want it that the market has become tight, he says.
"Maybe the better value is three- to five-year-old equipment," he adds. "There’s not as much competition for it." Producers need to keep in mind that in four years, it will be nine years old, and the eight-year-old piece will be 13. "Buying new or used equipment, like taxes, becomes very emotional," Peterson says.
A Multi-Year tax strategy can benefit the farm
While 2013 tax strategies are top of mind, it’s important to think long-term. "Cutting taxes in 2013 should not come at the expense of building adequate working capital for 2014 when corn prices could be $4 to $4.25 per bushel," says Paul Neiffer, CPA at CliftonLarsonAllen. "Cash and working capital are the life blood of a farm business."
Even though the tax code allows rapid write-offs with Section 179 and bonus depreciation, fully using them with major purchases is not the best decision for everyone, says Mark Olson, a CPA at Conway, Deuth & Schmiesing. "One concern I have is if a farmer buys a $400,000 combine with a five-year loan, he can write it all off in 2013. That would mean no depreciation to offset principal payments in 2014 and beyond," he says.
Additionally, income for livestock producers is forecast to be higher in 2014 than this year. For them, stretching out depreciation might make more sense than maxing out Section 179 and bonus depreciation this year, Olson adds.
While it seems advantageous to use deductions to offset higher income in 2013, there is no silver bullet. Farmers have several strategies they can use to reduce taxable income.
One strategy is to gift grain to charities and your children. If you are going to make gifts anyways, gifting grain, preferably in the prior year, allows you to avoid income tax and Social Security tax. Another option is to pay your children under the age of 18 for their labor. Each child can receive up to $6,100 to offset earned income, Olson explains.
Other ways to reduce tax obligations are the tried-and-true methods of income averaging, prepaying expenses and using deferred payment contracts on grain sold. But producers cannot deduct prepaid insurance premiums, real estate rent for 2014, and interest cannot be paid more than 12 months in advance, says Dennis Stein, Michigan State University farm management expert. Farmers can also fund a simple retirement plan up to $100,000, but the plans need to be set up by the end of the year, he says.
It’s important that all expense deductions be economically defensible. "The IRS will not accept shifting income or expenses just to avoid paying taxes," Stein says.