We got the following question from one of our readers:
"I'm downsizing and want to sell some of my depreciated equipment. If I sell it out right I will pay full tax the first year on sale price. Can I lease my Equipment to someone for five to ten years to have the income spread over more years."
This is one of those good news/bad news answers.
First, on equipment sales, you generally taxed on the full gain in the year that you sell the equipment even if you sell it on a contract over a few years. The only way you could defer this type of gain would be on the portion of gain which greater than the original cost of the equipment. Generally most used equipment is sold for a price less than what the farmer paid for it, so this would not apply.
The good news is that you can defer this tax by renting the equipment to the new farmer. You would report the rents as income and deduct any remaining depreciation that you can take on the equipment.
The bad news is that this net income is also subject to self-employment taxes in addition to normal income taxes. This increases your possible tax rate about 15%. However, if you are still farming and are already over the maximum wage base of about $107,000, then the extra net tax is only about an extra 2.5%.
Or if you own the equipment in a corporation and lease it out, you would not be subject to any additional self-employment taxes. Another possibility is to use a LLC to rent out the equipment.
So, in conclusion, you can defer the tax by renting out the equipment, however, it may be at a higher rate.