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I need to downsize my operation next year for financial reasons and plan to sell a combine I purchased in 2012. The combine is mostly depreciated. Can you give me an example of how much tax I might owe if I choose this option?
As an illustration, let's assume the combine can be sold for $220,000, and your remaining undepreciated tax cost is only $20,000. Obviously, you have a gain of $200,000 on the sale. The good news is that this income is not subject to self-employed social security tax, but the bad news is that it must be reported as ordinary income on Form 4797 (a schedule used to report gains from the sale of business property). A gain of that magnitude could run through several tax rates, touching perhaps the 25%, 28% or even 33% brackets. If we use 30% as an average rate, your federal tax cost on the sale would be an additional $60,000 of tax ($200,000 x 30%).
I am assuming that all of the gain is attributable to the depreciation (i.e., you are selling the 2012 combine for less than your original cost, and the gain arises entirely from the depreciation deductions that reduced your original cost). If a machinery item is sold for more than its original cost, the excess over the purchase price is capital gain. But that is exceptionally rare with the sale of used farm equipment.
Assuming you go ahead with the sale, you will want to build that gain into your year-end tax planning projection with your tax adviser. If the gain is large, it may make sense to reduce the Schedule F income with additional prepaid expenses or deferred sales. Also, be sure to check on the use of Schedule J, farming income averaging. The combine sale gain qualifies for farm income averaging. This will allow you to apply lower tax rates from the prior three years to any higher farm income this year.
[A career of deferred taxation poses hardships for any operator who attempts to retire cold turkey. To learn how to minimize the tax consequences, attend DTN University's "How to Retire Without a Monster Tax Bill," Dec. 6 just prior to the DTN Ag Summit in Chicago. See http://goo.gl/… for details.]
I am hearing that a lot of the lease arrangements, particularly for farm buildings, do not meet the tests of a true lease and are simply disguised purchase agreements. What are the rules in case I am audited?
Before we get to the factors on what characterizes a lease versus a purchase, we should be clear that this is simply a matter of timing of the deductions. If it is a true lease, all payments are deductible as rent expense when disbursed.