This has been an interesting six months. Back in January/February, I was very optimistic about the future of the agribusiness economy. Fast-forward five months, and we have COVID-19 and trade wars. With the prospect of another year or more of depressed commodity prices, many farmers are simply tired. When you face burning through more equity or stopping farming, more and more are opting to quit.
For those lucky enough to have a successor, the transition into retirement still has a fair amount of bumps in the road. Because of the number of farmers retiring in 2020, I want to go over installment sales. An installment sale is when the farmer sells certain property at a gain and gets paid over a period of years. The farmer is able to recognize income as it's paid, potentially avoiding high tax brackets. Although the concept is basic, there are some restrictions on what property is eligible and rules for related party sales.
Installment sales are common in agriculture. The most common installment sale associated with farming is the deferred payment contract.
An installment sale can be used to spread income from the sale of crops over a period of years in order to play the tax bracket game. However, the farmer is an unsecured creditor, and there is risk.
Other installment sales in farming include land and equipment. Unimproved land is straightforward. Gain is recognized as payments are made. However, when you have improvements, you must recognize the depreciation recapture in the year of sale.
The same is true for equipment.
You can sell a tractor under the installment method, but you must recognize deprecation recapture in the year of sale. For fully depreciated equipment, you pay all the tax in the year of sale and receive tax-free payments in future years. Not ideal.
There are also issues surrounding related-party installment sales. Sales of depreciable property (this does not include land) to a controlled entity does not qualify for the installment method. Controlled entity includes:
-- Taxpayer and all entities that are controlled (i.e., taxpayer owns, directly or indirectly, more than 50% of the entity).
-- Taxpayer and any trust with the taxpayer or spouse is a beneficiary.
-- Two or more partnerships in which the same taxpayer owns, directly or indirectly, more than 50% capital or profits interest.
Although there are restrictions on sales to entities, sales from an individual taxpayer to another individual, regardless of relationship, are eligible for the installment method.
Another issue with related-party installment sales is that if a related party disposes of the property within two years, the remainder of the installment sale is taxable in that year.
As a side note: I've seen related-party marketing companies set up for deferral of income purposes that fail this test. Usually, it comes as a surprise to the farmer and results in significant tax issues.
Installment sales are a powerful tool in farming. However, there is a level of complexity that needs to be understood. Prior to entering into an installment sale, consult with your tax professional.
DTN Tax Columnist Rod Mauszycki, J.D., MBT, is a tax principal with CLA (CliftonLarsonAllen) in Minneapolis, Minnesota. Read Rod's "Ask the Taxman" column at www.about.dtnpf.com/tax. You may email Rod at email@example.com.
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