Many farmers mistakenly assume that if they have a used piece of farm machinery and they want to get a newer piece to replace it, that a trade-in always saves them money at tax time. However, in many cases, this is not true and in fact, can cost the farmer up to $15,000 in self-employment taxes.
To maximize this tax savings, we would need a farmer who is self-employed and generally makes about $110,000 in net farm income for the year. If the farmer has a used combine worth at least $100,000 and wants to upgrade, the farmer has two options.
Under option #1, the farmer can go the local implement dealer and do a direct trade with the dealer. In this situation, the farmer incurs no taxable gain on the trade-in and whatever consideration is made for the excess over the trade-in value is allowed to be depreciated or take the Section 179 deduction on this excess.
Under option #2, the farmer simply sells the combine for $110,000 and uses the cash to purchase the new combine. Under this option, the farmer will recognize a taxable gain of $110,000 (assuming the combine has been fully depreciated) which is reported on form 4797 and flows through to the front page of the tax return. On the farmer's schedule F, they will be able to take Section 179 on the new combine equal to the $110,000 or cash proceeds received on the sale plus any additional consideration paid for the new combine. What is nice about this option is that the Section 179 deduction reduces the farmer's self-employment tax to zero. If the farmer normally has net farm income of about $110,000, this self-employment tax savings is at least $15,000.
Now to get this maximum tax savings, you need to have the right fact pattern. Normal farm income of about $110,000, trade-in value on old equipment of at least $110,000 and the new equipment bought should be for about the same price. Under this scenario, your tax savings would approach $15,000.
If you are ready to trade-in some equipment, make sure to run it by your tax advisor to see if makes more sense to sell the equipment and report the gain.