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Plan for transfer of farm machinery

Frequently, I receive questions regarding the sale or transfer of farm machinery between one generation and the next. The rules for taxation of depreciable assets are complicated.

In general, the seller of farm machinery must pay ordinary income tax on any amount of depreciation “recapture” that occurs. For example, if a tractor was purchased in 2000 for $50,000, completely depreciated over seven years, and then sold in 2010 for $40,000, the seller would have to pay ordinary income tax on the entire $40,000.

This $40,000 represents the amount of excess depreciation that was taken on the tractor. After all, it only lost $10,000 of value during the period of ownership, but $50,000 of depreciation was taken.

This $40,000 of taxable income is called depreciation recapture.

The tax on depreciation recapture must be paid in the year of the sale. There are no provisions in the tax code to spread the taxation of depreciation recapture over the life of an installment contract.

For example, Fred sells his combine to his son for $100,000 on a five-year contract for deed. Fred has depreciated the combine completely, and thus it has a tax basis of $0, resulting in depreciation recapture of $100,000. The tax on the $100,000 is due in the first year of the installment contract. If Fred is in the 25% federal tax bracket, his federal taxes will be $25,000 in year one of the installment contract, which is likely more than the initial installment payment.

Leasing Gifting

Gifting is a fairly common method for transferring farm machinery between parents and children. Children often trade in an old piece of Dad’s equipment for a newer model, and the trade-in-value becomes a gift to the child.

Gifting has drawbacks, too. First, the child does not receive a new tax basis on gifted equipment, but rather receives the old basis of the donor.

Second, the donor’s income needs may not be met if too much machinery is gifted.

Third, the annual limit on gifts to avoid gift tax exposure is $13,000 per year per donor per recipient. This can present a problem with pieces of machinery with a high value.

Piecemeal sale

A third method is to sell one or two pieces of farm equipment each year.

Often the piece selected for sale is one that is to be traded by the buyer.

One of the biggest drawbacks to this strategy is that sale of the larger pieces of equipment, such as tractors and combines, may result in a very large tax bill for the seller in that year.

We often see this problem in the case where a combine with a large debt and a low basis is sold, and the seller does not receive a large enough sale price to cover both his loan and tax obligations.

As always, consult your tax adviser before proceeding.


Anderson is a farm financial management consultant in Redwood Falls. E-mail him at bob@farmfinancialsolutions.com.

This article published in the September, 2010 edition of THE FARMER.

All rights reserved. Copyright Farm Progress Cos. 2010.