Is Section 179 a Ticking Tax Time Bomb

Published on: 17:41PM Jan 05, 2016

Most farmers took advantage of up to $500,000 of Section 179 over the last five years.  The recent tax extender bill has now made this permanent at the $500,000 level (indexed to inflation after 2015) and it does not start to phase-out until a farmer invests more than $2 million in farm equipment.

On the face, this sounds like a great tax deduction for farmers, however, with continued low commodity prices, might this be a ticking tax time bomb for many farmers.  This is due to a farmer having to liquidate some farm equipment due to the bank requiring additional liquidity be put into the farm operation or perhaps the farmer has lost some ground and no longer needs the equipment.   This sale of equipment causes the Section 179 to be "recaptured" as ordinary income and since the farmer probably does not have sufficient liquidity to prepay additional farm expenses, causes the farmer to be in a high tax bracket.  This leads to a large tax bill which then requires the farmer to sell additional equipment or grain to cover the tax bill.  This is especially harsh when the equipment was financed 100%.

As an example, let's assume that Farmer Brown had purchased a combine for $500,000 back in 2014 and took full Section 179 on it.  In 2015, the bank requires him to sell this combine for $350,000 (which paid off the note to the bank; Farmer Brown received no cash from the sale).  Farmer Brown now reports his normal farm income of $100,000 plus has a $350,000 ordinary income from the sale of the combine.  This results in about $150,000 of federal and state income taxes being owed.  This causes Farmer Brown to have to sell additional grain of about $150,000 in 2016 to pay his income taxes which causes additional tax liability of about $50,000 being owed in 2017. 

If Farmer Brown had not taken Section 179 in 2014, his tax liability might have been higher that year, but likely he would have had the liquidity to pay it and would not get stuck in the extra tax spiral as shown in the example.

One option to help Farmer Brown in this situation is to amend his 2014 tax return and take Section 179 on a different piece of property that was not sold (assuming he bought additional property).  The IRS allows you to amend your tax return and take Section 179 on other property.

I believe we will see more of these situations in 2016.  If you have some flexibility in your equipment, take a look at amending your tax return to help with the gain on selling equipment you took Section 179 on.