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Depreciation changes in federal tax reform package impact farmers

By Compeer Financial

Since the passage of the Tax Reform in late December, many people are still trying to understand the modifications and determine how this reform will affect them. Thankfully, Congress did not start with a blank slate as some presidential candidates promised; rather, they modified existing provisions while adding a sunset date to them. That means we will have to make the most of them until Dec. 31, 2025. How did the modifications impact farmers? Here are a few highlights of what changed and some simple examples of how it might affect you.

Let’s start out by taking a look at the individual tax return. For the married couple filing jointly, the first thing that should catch your eye is the increased standard deduction. For a couple who has minor medical costs, lower property taxes, and lower state income taxes, this increased standard deduction is a positive. It went from $12,700 in 2017 to $24,000 in 2018. The personal exemptions have been eliminated until Dec. 31, 2025, offsetting the increased standard deduction. Historically, we look at the standard deduction and personal exemptions as permanent tax deductions to help lower taxable income.

What does the change mean for a married couple with children? For 2018, the standard deduction will be $24,000 with no personal exemptions. In the past, having three kids, plus the couple would equate to five exemptions. A family would have had a standard deduction of $12,700 plus $20,250 from exemptions ($4,050 multiplied by 5) which together equals $32,950. With the new law, they are losing $8,950 of deductions.

Perhaps Congress did see this and tried to offset it with an increased Child Tax credit. If those children qualify for the Child Tax Credit and the couple’s income is under $400,000, then instead of getting $1,000 per child now the couple can get $2,000 per child of qualifying child credit which will reduce tax liability. Let’s say all the children qualify and the couple’s income is under the new increased threshold, meaning that couple could get a $6,000 child tax credit to reduce federal tax liability.

Next, let’s take a look at the business side of the tax reform. Some commentators have expressed the benefit of an increased limit to the Special Depreciation Allowance (referred to as Bonus Depreciation). In 2017, this rule allows an additional first year depreciation deduction equal to 50% of the adjusted basis on property with a deemed class life of 20 years or less. This is now increased to 100% and is retroactive to Sept. 27, 2017 with both new and used assets qualifying. If elected, this bonus depreciation would apply to all assets in one class per year. Meaning you cannot pick and choose the assets within a singular category.

A fitting example would be if you built a machine shop that was $250,000 and purchased no other 20-year assets in 2018. Bonus Depreciation allows you to depreciate 100% of the asset, thus leaving no depreciation deduction for the next year, or letting the whole building depreciate over the 20 years. If you have purchased another property at a 20-year class life, then you would have to elect Bonus Depreciation on all or none
of the assets in that category.

Another part of tax reform that deals with depreciation is the option which allows farmers to use an accelerated method of depreciation on certain assets. Currently, farmers have a choice between a 150% declining balance or straight-line depreciation. Now they may use 200% declining balance with the exception of 15- or 20-year class life properties. Once again, this could provide for accelerated depreciation and decreased farm income.

By accelerating depreciation, you can lower your current year tax liability and save current year tax dollars, but you should also examine what it may cost in future years. Planning is pertinent when looking at the current situation while staying focused on the long haul. Ultimately, it is your choice, but you should be cautious and consider the impact on future years.

Tax reform provides another depreciation change: the opportunity to use a shorter class life on certain new assets. For example, if you buy a tractor that has never been used (you are the first owner), you can now depreciate it over five years rather than seven, which it was previously.

One word of caution: if there is a note on the tractor for seven years; one should look at, consider matching the depreciation to the principal payments. This will provide a deduction while paying off debt. As lenders, we have found it’s tough to explain to a farmer that, while there is no cash in the checkbook, they have tax due because they paid down debt and don’t have the depreciation expense to offset the principal paid.

Another tax law modification that will warrant some planning, is the change making tax-deferred exchanges only permissible on real property. Personal property, such as equipment, will have to be recognized to the extent of the trade-in amount as a deemed sale. For example, if you trade in a tractor and the dealer gives you a trade-in allowance of $50,000, reducing the cost of the new one from $130,000 to $80,000, you will need to report the $50,000 sale of an asset as ordinary income and the new asset cost will be the full $130,000.

One last change that needs attention is the repeal of the Domestic Production Activities Deduction, known as DPAD. This deduction was available to offset adjusted gross income. Congress replaced the DPAD with a new 20% qualified business income deduction which will give a deduction but will not reduce adjusted gross income. Another caveat is that only individuals, partnerships, and S-corporations will be allowed to compute the deduction. C-corporations will instead benefit from the flat 21% tax rate imposed on them.

This elimination of the DPAD could be a huge factor for health insurance that is purchased through the marketplace if the individual has taken the premium tax credit in advance. Many times, year-end tax planning opportunities are discussed to ensure that the client stays within the desired income that they used to apply for health insurance. The new 199A deduction will not be allowed to reduce adjusted gross income. So if the current DPAD has been used in the past to reduce the AGI, this will reduce your Premium Credit.

With all the tax reform changes, you have to look not only to this year but to years down the road. With the sunset provisions and potential future tax code changes, the key is having a solid relationship with your tax consultant. Together, with an attorney, your lender, and your tax consultant, you can plan and be proactive for success not only this year but for the years ahead.

This article was a collaboration by the team members of Compeer Financial’s tax and accounting department. For more on tax planning, see Compeer.com.

 

From the March | April  2018 Issue

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