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.
Anderson is a farm financial management consultant in Redwood Falls. E-mail him at firstname.lastname@example.org.
This article published in the September, 2010 edition of THE FARMER.
All rights reserved. Copyright Farm Progress Cos. 2010.