Ask the Taxman by Andy Biebl - How Can I Retire Without a Tax Hit?

DTN Tax Columnist Andy Biebl is a CPA and principal with the accounting firm of LarsonAllen in New Ulm and Minneapolis, Minn., and a national authority on ag taxation. His monthly features also appear in our sister publication, The Progressive Farmer magazine. To pose questions for upcoming columns on DTN, email AskAndy@dtn.com

Question:

My husband and son have been farming together for years, with each having their own equipment and land. In the last 10 years, in order to get larger equipment, they have shared the cost at 50% each. They now have over $100,000 each in their own share of this equipment. My husband would like to retire, and sell our son his half of the equipment. We would like to do this over a period of years. Can this legally be done and how? All of the equipment has been written off using the first-year deductions, so there is no remaining tax cost.

Answer:

If your husband sells his 50% share of the equipment to your son on an installment note, the tax result is harsh. Under "depreciation recapture" rules, the gain attributable to prior depreciation is entirely taxed at the point of sale, even though the payments are deferred. In other words, it is not possible to use installment tax reporting for depreciable equipment.

The usual solution is to have your husband retain ownership of the equipment, and lease that equipment together with his land to your son. If you use a single lease that combines real estate with equipment, there is no self-employed Social Security tax on the rental payments. Then, as your son needs to replace the various items from time to time, he purchases the 50% share of each item when it is time for the trade.

There is another alternative, but probably overly complicated in view of the amount of equipment that you have. When the machinery line is more extensive, we look at forming an S corporation to conduct the combined farming operation for a period before retirement. Then, when it is time for your husband to retire, he sells his portion of the S corporation stock on an installment note. This allows both deferral of the gain under the installment method and capital gain reporting to dad (rather than ordinary income rates), and the son receives friendly financing on a longer term note due to dad. True, the son does not receive any fresh depreciation because he has purchased stock. That can be reconciled by applying a discount to the purchase price of the stock, essentially splitting the benefit to dad of capital gain rates and the detriment to son of losing a fresh tax cost.

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Question:

I am 60 years old and operate farmland in two states. My only son has no interest in farming. What do people without on-farm heirs need to consider in their estate plans?

Answer:

A major issue is managing the tax costs of disposing of your machinery and all of that carryover grain. In the year you retire, you will no longer have prepaid expenses as an offset to deferred grain sales. There is no magic solution to that problem, other than an individualized tax plan with your adviser.

Farm income averaging (Schedule J) can help hold down the income taxes by applying tax rates from the prior three years. Managing the self-employment tax on the grain sales, if you are a proprietor, is also a big issue. It is generally better to have one big year and fill up the 15.3% base just one time (roughly $107,000 of self-employment income), rather than spread the grain sales over multiple years, especially if you can use income averaging to keep the income tax rates in control.

One technique which can stretch things out and help lower the marginal income tax rates is the use of a Charitable Remainder Annuity Trust or CRAT. These work particularly well with carryover grain, as the annuity you receive back from the CRAT is exempt from SE tax. If the grain is transferred to the charitable trust, the trust sells it tax-free, and then pays back an annuity over a term of years that you set at inception (generally we use about 10-15 years, but it is a case-by-case situation). There is a requirement of a 10% carve-off to charity at the end of the trust (based on present value at formation of the trust), but the income tax and SE tax savings can actually be greater than the charitable outlay and make this a net winner.

After your operating assets are disposed of, most in your position become landlords and use the rental income as the core of their retirement income. From an estate planning standpoint, the key issue is usually whether to divide the land by bequeathing a portion to each heir, or alternatively placing the land within an entity (usually a limited liability company taxed as a partnership) so that the rental income from the entire land base is shared by each heir. You'll need to visit with your attorney or tax adviser about those choices.

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Question:

My brother and I are equal partners in our farming S corporation. We put up a machine shed that was started in October 2010 and finished November 2010 at a cost of $45,000. We used the 100% bonus depreciation for the building. Now we are adding a concrete floor at a cost of $30,000 in 2011. Will we be able to use the 100% bonus depreciation?

Answer:

The 100% bonus depreciation deduction remains available for property placed in service through Dec. 31, 2011. For agricultural businesses, bonus depreciation is available for both machinery and buildings. In agriculture, all assets have a depreciable recovery period of 20 years or less, and that aligns with the eligibility definition for the bonus depreciation. As a result, your concrete improvement to the machine shed qualifies for 100% bonus depreciation.

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Question:

I have read about the 100% bonus deduction for new equipment purchases. But what about purchasing a used tractor? I bought a 2009 John Deere 9530 in April of 2011. What are my depreciation options?

Answer:

The 100% bonus depreciation in 2011 and 50% bonus deduction in 2012 are only available for new property. For used property, the only first-year alternative is the familiar Section 179 deduction. The limit on that is very generous for the 2011 tax year: Up to $500,000 of eligible property additions can be expensed. For tax years beginning in 2012, the annual limit drops to $125,000 (but with an inflation adjustment that should move the number closer to $130,000). Further, if there was a trade-in, it is only the "boot" or additional cash payment that qualifies for the Section 179 deduction.

 

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