Ask the Taxman by Andy Biebl

Can I Retire Without a Tax Shock?

You'll owe income taxes on the full value of any equipment sold in year one, even if you use an installment contract to make payments more affordable for the new buyer. (DTN/The Progressive Farmer photo by Jim Patrico)

DTN Tax Columnist Andy Biebl is a CPA and principal with the accounting firm of CliftonLarsonAllen LLP in New Ulm and Minneapolis, Minn., and a national authority on agricultural taxation. To pose questions for upcoming columns, email AskAndy@dtn.com.

QUESTION

My wife and I operate a 600-acre grain farm and are ready to retire. We have no family members interested in farming, but there is a young neighbor couple that would like to buy or lease our farm. Our land is worth about $4,500 per acre. The young couple also would purchase our equipment, which is worth about $750,000, using some type of affordable payment plan. We both have small Social Security income coming, and my wife has a small pension. We will keep the farm house, but buy a smaller home in town as our primary residence. Can you give us some help on what to do here?

ANSWER:

Let's start with the machinery, as that clearly needs to be sold. But the tax laws are harsh: Any sale, even for no down payment and over installment terms, results in full "depreciation recapture" at ordinary rates, not capital gain rates. That's a harsh answer, as it means you would incur the entire income tax in the year of sale, even though the payments are stretched out over a number of years. If transacted in this manner, you would likely incur more tax in that first year than any cash collected. Depending upon your taxable income for the prior three years, farm income averaging may reduce the sting from reporting the equipment sale gain all in the year of sale.

As to solutions, there is really only one choice: A short-term lease that is rewritten every year or two to reflect the diminishing value of the equipment. This won't produce the level payment stream they probably desire, but it's more reflective of the actual economics, and also protects you better in the case they abandon the arrangement after a few years. After the equipment has diminished in value (perhaps five to seven years), you can then execute a sale without the severe tax consequences. The young couple will want a separate option agreement, giving them the right to buy the equipment from your estate, in the event the two of you die before the plan can be completed. From time to time, there may be a need to replace a piece of equipment; they can purchase that from you and accomplish the trade-in.

In summary, you'll need good legal and tax help with the leases and the option. Finally, don't take any shortcuts; the IRS is quick to recharacterize a sale document that is naively labeled as a "lease" at the top of the document.

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As to your land, we normally do not see a sale at the point of ceasing the farming. The rental income is a valuable retirement resource; it is adjustable in times of high inflation. If you sell, you're going to lose about 25% of your gain in federal and state capital gain taxes, and the residual will only grow based on your ability to manage the investments.

Consider a cash rent arrangement with that young couple. If you want to protect their right to buy the land from your estate (when your children will incur no capital gain tax because of the estate step-up in basis rules), you could write a buy-out option in favor of the young couple into your will or trust.

QUESTION

Two questions on the same point:

1. Your recent article on charitable giving discussed the option of transferring ownership of grain to charity and said this was not available to crop-share landlords. Why is this the case? Landlords can also have grain to market.

2. I have been donating grain to a charitable foundation which then distributes to the charities that I direct. They now tell me that since I have rented my land on a share basis for 2014, I can no longer continue this. Is that correct?

ANSWER:

In terms of a charitable contribution, the tax law looks to the status of the grain in the hands of the taxpayer making the donation. To an active farm producer, whether a proprietor, partner or corporation engaged in farming, the grain is inventory. Inventory gifts to charity are permitted; when that inventory is sold, the charity has the income. But grain in the hands of a crop-share landlord represents accrued but unrecognized rental income. Income rights cannot be assigned to another party. This principle was established in several IRS rulings back in the 1970s. So, long story short, what is feasible for an active producer is not available to a crop-share landlord.

QUESTION:

We saw your comments about gifts of inventory. Can we do that with alfalfa hay? Can we set aside a stack of hay for the church and then have them sell it?

ANSWER:

The key to a successful gift of unsold inventory to a charity is to understand that it is a two-step process. First, you transfer title to the unsold grain or hay to the charity. Secondly, the charity independently sells the grain or hay. If the inventory is with a commercial elevator or warehouse, the first step is easy because title to some portion of the commodity can be readily changed to the charity. But gifts of commodity on the farm need documentation to support the first step, such as by a bill of sale. Your local attorney can help draft that and convey it to the charity. It's then up to the charity to conduct the sale; this might include providing direction to you in assisting with the sale on the charity's behalf.

EDITOR'S NOTE: For more in-depth strategies to avoid retirement tax shock, join CPA Andy Biebl and other expert faculty at the Ag Summit in Chicago Dec. 7, 2014, for a DTN University workshop, "Over 55: Make Retirement Less Taxing." Find DTN U details at http://www.dtnprogressivefarmer.com/…

Andy Biebl can be reached at AskAndy@dtn.com

(MZT/AG)

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