Have you heard talk at the coffee shop or grain elevator that the new tax law will prevent you from a tax-free exchange of your farm equipment? Yes, it is true for exchanges completed after 2017. The new tax law, known as the Tax Cuts and Jobs Act of 2017, modified IRC Sec 1031, which provides for nonrecognition of gain in the case of a like-kind exchange by limiting nonrecognition to real property. Like-kind exchange for personal property (i.e. equipment) is now no longer allowed. At first glance, this change doesn’t seem very taxpayer friendly. However, before we come to any conclusions, let’s compare examples of a trade in 2017 to one in 2018.
How Did the Old Rules Affect My Taxes?
In 2017, Fred Farmer buys a new tractor. The cost of the new tractor is $400,000, but Fred decides that he wants to trade in his old tractor, too. The dealer provides a trade-in value of $150,000 for the old tractor, leaving a balance due to the dealer of $250,000. Fred’s old tractor has been fully depreciated (written off in prior years). For tax purposes, the $150,000 trade-in value is ignored, and Fred Farmer will depreciate or, most likely, write off the $250,000 (net cash paid).
How Do the New Rules Affect My Taxes?
Let’s use the same set of facts as above, except now the trade takes place in 2018. The new rules require that the trade-in value of $150,000 be treated as if the equipment is sold. Because the old tractor was fully depreciated, Fred will recognize a taxable gain and report on Form 4797, not his Schedule F. Under these new rules, the depreciable basis for the new tractor is $400,000, plus the new law allows for 100% bonus depreciation as a deduction on Schedule F.
At the federal level, these new rules (which expire in year 2022) could trigger less tax than the old rules. Here is why: in 2017, assuming Fred had enough pre-depreciation farm income, he could write off the entire cash price of the tractor ($250,000), which shows up as a deduction on Schedule F and reduces the amount subject to self-employment tax (15.3%). In 2018, Fred can take 100% of the cost of the tractor ($400,000, not $250,000) on Schedule F without any pre-depreciation income limitation. The gain Fred recognizes from his 2018 trade ($150,000) is subject to income tax, but NOT self-employment tax (15.3%). The additional depreciation deduction of $150,000 in 2018 could save him $22,950 in self-employment taxes! The new tax law also treats the gain on the trade of the equipment as Qualified Business Income for purposes of calculating the new 20% Qualified Business Income Deduction!
The new rules are complex, and income tax planning is a comprehensive process. Therefore, it is essential to work with an advisor than can help guide the process and understand your own unique situation. If you are contemplating a trade of your equipment or need help with year-end tax planning, Sikich tax professionals are available to work with you.