There were many changes to the tax law in 2018, but one big change has not gotten a lot of attention. This change will affect almost every farmer in the United States. Starting January 1, 2018, when you trade a piece of equipment at the dealership, the IRS will not recognize that transaction as a trade. Instead, according to the IRS, you have sold your old piece of equipment and purchased a new one in two separate transactions. The only item that can now be “traded,” according to the IRS, is real estate.
Here is an example of a tractor trade and how it would be reported under both the old and the new rules:
Steve went to town and traded off his old fully depreciated John Deere tractor worth $80,000 for a newer CIH Tractor worth $150,000 and gave the dealership a check for $70,000.
In 2017, Steve’s tax return would show the old tractor was traded for the new and Steve would depreciate $70,000. He could write off the whole $70,000 in the first year or depreciate it over time.
In 2018 Steve’s tax return would show that he sold the old tractor for a gain of $80,000. He would then show on his depreciation schedule a tractor purchase of $150,000. He could then write off up to $150,000 in the first year or depreciate the $150,000 over time.
With the rules for fast depreciation, Steve could write off enough of the new tractor to offset the gain on the old equipment. At first glance it appears that, other than more lines being shown with numbers on his return, nothing really changes. But consider how each type of income is taxed and Steve’s ability to control how much tax he pays is enhanced with this change in the law. The gain on the tractor is considered “ordinary income, not subject to self-employment tax.” This means that the $80,000 will be taxed at Steve’s income tax rate. The depreciation on the new tractor will lower Steve’s Schedule F Farm Income that IS subject to self-employment tax. If Steve decides he wants to write off an extra $80,000 of the new tractor to offset the sale reported on the old, not only does he save regular income tax but he also saves $12,240 of self-employment tax ($80,000 x 15.3%). If Steve is older and has become concerned with the amount of Social Security he will be receiving at retirement, he may actually consider not trying to offset all the gain on the old tractor. He can increase his average Social Security earnings by writing off less of the new tractor. If Steve is in a loss situation for his farming operation, the reporting of the old tractor as a sale and then writing off less of the new tractor may help prevent Steve from reporting a loss on his tax return. This eliminates waste of any tax deductions and improves the look of his return for borrowing purposes.
As you can see, the new tax law has created some more considerations for farmers when it comes to updating equipment. From a reporting standpoint, it is even more critical that your tax preparer is given copies of your paperwork involving equipment purchases. The dealership may still consider your transaction a trade, but for IRS reporting your tax preparer will need many more details than in the past to properly report these transactions to the IRS.
Disclaimer – Descriptions provided in this article are presented as generalities. There are many factors not listed above which may impact your return. This article should not be considered legal or tax advice. For advice on a specific transaction, please contact the AgriSolutions Tax department at firstname.lastname@example.org .