Originally published in Michigan Farm News
The old adage: nothing is certain except death and taxes rings true for many farmers determining the right time to sell farm assets. Given the tough economic drought farmers are facing, many are looking for ways to generate cash and are considering selling non-productive assets, while others may be looking to sell the entire operation. Even in situations where a farm is struggling with cash flow or debt repayment, they may find themselves with a considerable tax burden when they sell assets. Therefore, it is critical to prepare and plan as far in advance as possible to develop a systematic approach to selling farm assets.
There are many criteria which will affect individual situations such as volume of assets, depreciation schedules, previous tax strategies and debt structure which all need to be taken into consideration when determining the items to be sold and the timing of the sale. Given the complexity of most farm businesses, having a long-term plan in place ahead of the sale will provide the most benefit to the owner.
The following suggestions are based on my 20-plus years of working with farm families and my day-to-day working knowledge of the new tax laws. This list can help you begin the planning process, however I encourage you to work with a tax consultant familiar with farm assets that can review your individual information.
Communicate with your lender(s): If you are considering the sale of assets that are held in lien by a lender it is important to communicate with them your plan to sell the asset and determine how the proceeds of the sale are to be applied to the debt.
Update the balance sheet and appraisal: Knowing the true value of all your assets is the first step in deciding which assets to sell. Having a recent appraisal on your assets will help you when calculating current values for tax purposes and may be needed if called for an audit. Most appraisals are relevant for up to five years.
Clean up depreciation schedules: The first step I take when working with a farmer looking to sell assets is to make sure the depreciation schedule is current and items fully depreciated are removed. The proceed or gain, from any asset sold is taxed one of two ways, depending on their depreciation status or how the asset was obtained.
- Capital Gains: are taxed at a rate of 0 to 15 percent dependent on the individual’s income level.
- Ordinary Gains: are taxed at a rate of 10 to 20 or 22 percent and are also dependent on the individual’s income level. You will note ordinary gains have a minimum rate of 10 percent and a much higher cap than capital gains.
In both cases, the gain is determined based on the asset basis and the selling price. The tax basis for land is the price paid for the land or its value when it was inherited. Any improvements added to the land such as tiling, can be added provided they were not a deduction on previous tax returns.
Basis for facilities and machinery is their original cost or basis, minus any depreciation that was written off in prior years. Fully depreciated equipment (five years) will have a zero basis.
Raised livestock two years or older generally have a tax basis of zero whereas the basis for purchased cattle is the cost minus any depreciation taken in previous years.
If you are selling assets to pay off a debt, it is important to know that the proceeds from the sale may still generate a gain, likewise, if you let a lender take receivership of a piece of property, the amount of the debt eliminated is viewed as the sales price. Therefore, even if you do not receive any payment for the sale, you may still incur a tax obligation.
Design a Plan: Having a systematic approach to the order in which assets are sold can reduce tax implications. The following begins with assets subject to the lowest tax burdens to more complicated and possibly higher taxed items.
- Livestock over two years of age: Cattle over two years of age receive preferential capital gains treatment. Purchased cattle are considered ordinary gains when sold.
- Young stock: Depending on market prices, cattle over two years of age may bring a higher return than young stock so the owner needs to determine, based on input costs and project selling price if it is more advantageous to raise the animals and capture more value in the market than selling as youngstock.
- Machinery: Gains from selling fully-depreciated machinery will be taxed in the same manner regardless if the machinery is sold at one time or in installments. The tax burden will be the same regardless of how the payment is structured, so those selling machinery in installments do not realize any tax savings.
- Facilities: Facilities that have been fully depreciated, have a basis of zero. For facilities not fully depreciated the basis is the purchase cost or value at the time of building plus any improvements, minus any depreciation.
- Land: Land is by the far the most difficult sale for a farmer and generally one of the last assets to be sold. Gains from the sale of land will be taxed as capital gains. The gain is calculated based on the selling price minus the basis. For example, if land is sold for $100,000 and the adjusted basis is $20,000, the taxable gain is $80,000.
- Crops/Feed: Standing crops sold with the land are taxed as capital gains whereas harvested crops sold as inventory are taxed as ordinary gains. Therefore, if land is to be sold in the fall it may be advantageous from a tax perspective to sell the crop in the field versus harvesting and selling the crop. Crops sold as feed need to have a bill of sale indicating the price paid for the crop.
- Personal property: Married couples who have lived in the residence for more than two years can realize up to a $500,000 gain in the sale of their residence without generating a taxable gain. With this in mind, it is important to apply as accurate a value as possible on the value of the residence when selling a home attached to land.
- Personal investments (IRA’s, etc): When looking to tap into investment portfolios it is important to know the structure of the investment (Roth versus IRA, etc) and the length of time you have had the portfolio. Roth IRAs held for more than five years, or the owner is older than 59 1/2 are not taxed. When determining other investments to sell, those with a higher basis and less appreciation will incur the less tax burdens. Investments held for longer than a year are subject to capital gains while those held for less than a year are taxed as ordinary gains.
Communicate with your financial advisor(s): Throughout the difficult process of selling assets it is helpful to keep an open line of communication with your trusted financial advisors. Your accountant, lender or other farm consultant can help you make the best business decisions at what understandably, can be a very emotional time. Having a trusted advisor knowledgeable in agricultural markets and current tax laws can help you maximize tax credits while hopefully, minimizing tax burdens.