Susan K. Voss, CPA, has over 30 years of public accounting experience, and she specializes in farm operations, agri-business, and individuals and their closely-held businesses.
In continuation of Susan’s last article, let’s review another key IRC Section 179 issue impacting Iowa’s agricultural community. Thank you Kristine A. Tidgren from the Center for Agricultural Law and Taxation at Iowa State University for continued clarification of tax matters affecting the agricultural community. The following is a summary of an article she recently made available.
The change to IRC Section 1031 limits like-kind exchange treatment to real property, causing concern for many Iowa farmers. Without a tax deferral treatment available to personal property in 2018, equipment and livestock “trades” are fully taxable events. The taxpayer computes gain (or loss) based upon the difference between the amount realized on the trade allowance associated with the sale of the relinquished asset and the adjusted basis in the asset. There is no tax deferral for capital gains or depreciation recapture. This means there will be realized-reportable gain on the sale of the trade on the federal return. As of now, not the Iowa return.
A typical farm equipment trade will now likely trigger significant Section 1245 recapture, which is taxed as ordinary income. Under pre-law, Section 1031 tax deferral treatment was mandatory with a trade. This meant the ordinary income from the recapture was not recognized and the tax was deferred.
Example of the Impact
In 2017, John traded a tractor with a trade value of $75,000 and an adjusted tax basis of $0, plus $50,000 in cash, for a tractor with a fair market value of $125,000.
Under old law, IRC Section 1245 recapture was deferred, and the basis in John’s replacement tractor was $50,000 ($0 basis in relinquished tractor, plus boot paid). John reported the transaction on Form 8824, and could generally use IRC Section 179 to immediately expense $50,000, the cash paid in the transaction.
In contrast, the 2018 treatment is as follows:
In 2018, John “trades” a tractor with a trade value of $75,000 and an adjusted basis of $0, plus $50,000 cash, for a tractor with a fair market value of $125,000.
This transaction is a sale and a purchase. John must now recognize $75,000 in § 1245 recapture. The gain is reported and taxed as ordinary income. John’s basis in his new tractor is $125,000, the full purchase price of the tractor including the trade value. John can likely use federal IRC § 179 to expense that amount in 2018. If Section 179 is not available, he can use 100 percent bonus depreciation to capitalize and depreciate the cost of the purchase.
However, in Iowa, John will be treating this transaction as a like kind exchange. No sale to recognize and the ability to write-off the $50,000 cash paid to trade tractors. In fact, he will be able to expense $70,000 of his total purchases on the Iowa return this year, with limits. This is up from $25,000 allowed last year. Ask your tax preparer how many different depreciation schedules they are maintaining for you. Could be five!
Before the loss of the like-kind exchange, it was estimated that the Iowa Section 179 limits impacted a significant number of Iowa farmers. It was estimated that raising Iowa’s Section 179 dollar limitation to $100,000 and its phase-out to $400,000 would benefit 8,554 farmers. Raising the deduction to $520,000, with a phase-out of $2,070,000 would impact 9,137 farmers. With the loss of personal property like-kind exchange and the subsequent recognition of ordinary income on nearly all equipment trades, these numbers will be higher in 2018.
Iowa adjusted their $25,000 limit on depreciation to $70,000, however, the federal government is not changing the new tax bill as it relates to like-kind exchanges. If you’re in a tax position where the Section 179 deduction off-sets the gain on the “sale” of the trade, there may not be a large impact on your return. If you’re a regular corporation who recently elected Sub Chapter S status, please contact your tax professional about the “sale” of traded equipment.
This new tax bill has the potential to negatively impact your return, particularly when it comes to trading depreciated equipment or livestock. However, we’re here at TDT CPAs and Advisors to help you plan and understand your options. Give us a call if you find yourself in a Like-Kind-Exchange situation.