Trade In or Sell-and-Buy: Depends on Taxable Loss or Gain From Deal

By Jane Fyksen Crops Editor - agriview.com

Growers looking to replace farm machinery are faced with the decision to trade it in or sell-and-buy. Bill Edwards, Iowa State University Economist, suggests trading if a taxable loss will result. “Sell and buy if a gain will result and you are in a low tax bracket,” he directs.

Most producers replace major pieces of machinery by trading them in to a dealer in exchange for a newer model. The cash difference paid to trade n the “boot” n varies with the trade-in value, the new equipment’s list price and how much of a discount the dealer is willing to give. Trade-ins are also generally more convenient than having to try and sell the old equipment outright.

Think taxes, though, when choosing to trade equipment or sell it and buy new.

“When a depreciable item is disposed of in a ‘like-kind’ trade, any remaining tax basis is added to the cash paid to complete the trade, and becomes the beginning tax basis of the new machine,” Edwards points out.

In sell-and-buy, the new equipment has an initial tax basis equal to its purchase price (since there’s no trade-in). “However, the treatment of the income received from the sale of the old machine is uncertain,” mentions Edwards. “if the machine is sold for more than its final tax basis, a gain is created. Usually this is reported as recaptured depreciation and taxed as ordinary income.” Revenue in excess of the initial tax basis is taxed as capital gain.

“Neither of these is subject to self-employment tax,” he notes, noting that a sell-and-buy transaction with a gain creates tax savings because the gain doesn’t generate self-employment tax. It’s partially offset, though, by the fact that depreciation deductions from the original machine are now pushed farther into the future.

Edwards says for low-income tax bracket producers, sell-and-buy will still produce the most tax savings. But for those in high tax brackets, sell-and-buy gives about the same results as trading in.

He says if a piece of farm machinery is sold for less than its final tax basis, a capital loss is created. “If there will be a loss on the sale,” he notes, “the trade will always be preferred over a sell-and-buy transaction.”

Looking at how income tax basis for a $125,000 200-horse tractor would compare with its estimated remaining market value (with no Section 179 expensing taken), Edwards notes that after the first two years, a sale most likely will result in a gain n unless the tractor is sold for considerably less than average market value.