As farm financial stress creeps in across rural America, some producers may off-load machinery in the coming months. While effective at generating quick cash, this decision can have negative repercussions in the following tax season.

Generally, depreciation recapture reflects the taxes owed when a farmer sells equipment where the sale price exceeds the tax basis. These sale proceeds may be taxed as ordinary income. Producers may consider these strategies to manage their recapture exposure in the event equipment is sold.

Depreciated vs. undepreciated equipment

Like a sale of land, the tax basis of the equipment to be sold can be impactful. If those items have been fully depreciated using Section 179 or bonus depreciation, the tax basis may be low or nonexistent.

Conversely, if a farmer has elected to use the depreciable life of the equipment (generally, seven years), the items may have remaining tax basis. As a result, depending on the sale price of the equipment, depreciation recapture may be reduced or eliminated since the proceeds are closer to the tax basis.

Full sale, installment sale or piece-by-piece sale

If equipment is completely depreciated, full and immediate sales of equipment are ill-advised. Reason being, as expected, it triggers the depreciation recapture.

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What if you spread out payments over a period of years through an installment sale? This is also ill-advised, as the depreciated recapture payments are due in full in year one of the installment sale. Many producers would not have the cash to make this full tax payment.

If you are considering a sale of many equipment items and have the time to spread out a sale, selling piece-by-piece over several years can help spread out the taxes. Recapture is only triggered on an item when it is sold. This idea does not eliminate the taxes, but it does help distribute them over time.

Leasing equipment

Leasing out equipment instead of selling out might provide a path to tax management. This would produce rental income instead of depreciation recapture. Several rent structures may be considered, including flat rates, percentage values of the equipment or a rate per hour.

Lease-to-own arrangements are normally ill-advised, as the IRS may consider them installment sales (see above). Instead, consider renting out equipment under a lease, then execute a separate document containing an option to purchase at the end of the lease. 

Charitable remainder trusts

One complex yet effective strategy involves charitable remainder trusts. These trusts require extensive planning to set up and manage, and the seller loses a portion of the sale proceeds to a charity. However, the rest of the sale proceeds outside of the charity payment can be paid back to the seller as an annuity.

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Depending on the annuity details and other factors, the taxes paid on the annuity payments would be owed as they are received. Again, this serves as more of a tax distribution strategy, and the costs of implementation should be a factor when under consideration.

These options should be carefully considered with your legal and tax professionals. Each one has benefits and drawbacks, because in the end, machinery sales can be a minefield of bad tax outcomes.

Conklin is the lead farm succession attorney at Wright & Moore Law Co. LPA. Wright & Moore is licensed to practice in Ohio and Indiana. Individual state laws may differ.