Farmers recently received some welcome tax relief for machinery and equipment purchases, says Roger McEowen, director, Iowa State University Center for Agricultural Law and Taxation.
“From a farm tax standpoint, one of the biggest changes for 2010 and 2011 is the expansion of the Section 179 tax deduction to $500,000, and the introduction of 100% bonus depreciation for new assets bought after Sept. 8, 2010 and before Jan. 1, 2012,” he says. “Thus, almost all farmers who purchase new and used equipment during these time periods will be able to completely deduct their purchases if they so choose.”
Previously, the limit on Section 179 tax deductions was $250,000 and the limit on bonus depreciation was 50%, he explains.
Although maximizing deductions for all farm equipment purchases may sound like a sensible financial strategy, there are instances when taking those deductions could be financially detrimental, McEowen cautions. One major consideration is how long you intend to own the equipment before reselling it.
“If you take a deduction on an asset you purchase, then sell that asset after only a few years, you might have to pay a hefty tax on the tax savings captured by taking the deduction,” McEowen says. “When considering a deduction, you may want to sit down with a tax counselor to ensure you’re not stuck with what’s called ‘depreciation recapture’ further down the road.”
The following example helps illustrate other important considerations when making tax-deduction decisions on a farm-asset purchase: “Let’s say a farmer is purchasing a tractor this year,” McEowen says. “First, the farmer must decide whether to take a Section 179 deduction and/or bonus depreciation. The Section 179 deduction can be as high as $500,000, and applies to both used and new equipment, whereas the bonus depreciation only applies to new assets.”
However, there are two limitations to the Section 179 deduction:
- The farmer must have taxable income from farm operations and other businesses that are at least equal to their planned Section 179 deduction (including most wages they earn), and
- They must not purchase more than $2 million in equipment in the current year. Purchases above this amount start to reduce the Section 179 deduction dollar for dollar.
“In the case of this farmer, as long as the farm is profitable and the net income from farming is more than the cost of the tractor, then the farmer will be able to completely deduct the cost of the tractor in 2011,” McEowen adds. “Any amount not deducted under Section 179 will be depreciated over seven years.”
Farmers can follow five general rules to make the most from new, tax-law deduction changes related to farm asset purchases, says McEowen.
- Take 100% bonus on new assets that qualify (class life of 20 years or less, which includes most new agricultural buildings) and then Section 179 tax deductions on all used assets that qualify (special rules can apply if assets are leased), including single-purpose agricultural structures, such as a hog confinement facility, but no real estate.
- Take the highest amount of Section 179 tax deductions possible on assets with the longest class life first. “For example, if you have $100,000 on a 10-year property and $600,000 on a seven-year property, take Section 179 on $100,000 of your 10-year and $400,000 of your seven-year property,” McEowen says.
- Take 50% bonus depreciation on all other new assets that qualify.
- Take normal depreciation on any remaining value.
- Consider meeting with a tax professional to evaluate tax implications for both past and future farm asset purchases.