Machinery Sharing, An Option In Farm Transition

Ron HaugenNorth Dakota State University

Extension Service

04/21/23

2012 National Women in Agriculture Educators Conference Memphis, Tennessee

March, 2012

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Acknowledgments:William Edwards, Iowa State UniversityDon Hofstrand, Iowa State UniversityDwight Aakre, North Dakota State UniversityWillie Huot, Grand Forks Co Extension Agent, NDSU

Partial Funding was Provided by a Grant from the North Central Risk

Management Education Center

GRANT ENTITLED:•Transitional Strategies and Planning for Beginning North Dakota Farmers

– Emphasis on Machinery Sharing

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Background• Ongoing need for farm transition planning• 50% of North Dakota farmers have no

transition plan• 26% of North Dakota farmers are 65 years old

or more• 52% of North Dakota farmers are 55 years old

or more• 78% of North Dakota farmers are 45 years old

or more4

2007 Census of Agriculture

Machinery Sharing and Transfer of Ownership

March 2012

Ron HaugenFarm Management Specialist

NDSU Extension Service

Machinery Sharing

• Informal sharing of machinery• Often without formal agreements• Not considered long-term• Custom rates often used to settle accounts

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Joint Ownership(formal agreements)

• Written agreement• When and how to determine use• How to dissolve agreement• How to determine value at dissolution

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Why Joint Ownership?

• Lower cost of ownership• Have use of newer technology• Labor benefits• Less capital needed to get started

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Sharing Costs

• Costs should be shared equitably• If each parties’ use is about equal

– Each provides own fuel and labor– Repairs– Finance payments– Cash boot to trade– Income tax deduction

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Unequal Use

Al and Chris purchase a combine togetherAl harvests 1,000 acres; Chris 500 acres

• Use matches ownership– Each provides his own fuel and labor– Al owns two-thirds and Chris owns one-third– Al pays two-thirds of repair and ownership costs

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Unequal Use – Example 1

Used in a different proportion than ownership

1.Al and Chris jointly purchase a combine for $150,000. They each agree to contribute $28 per acre to a separate combine account.

Al - $28/acre x 1,000 acres = $28,000Chris - $28/acre x 500 acres= 14,000

$42,000

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Example 1

2. The following expenses are paid from the account:

Fuel and lubrication $ 7,200Repairs and maintenance 4,500Labor (hours/acre @ $12) Paid to Al: 300 hours 3,600 Paid to Chris: 150 hours 1,800Depreciation, interest, insurance andhousing (16% of value of combine) Paid to Al 12,000 Paid to Chris 12,000

$ 41,000

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Example 1

3. The excess funds can be carried over to the following year, or refunded in proportion to each partner’s use of the combine

Income $42,000Costs 41,000Excess $1,000

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Example 2Partner with most acres reimburses other owner for extra use. Al and Chris own combine 50-50Al harvests 1,000 acres; Chris 500 acres

Both furnish their own fuel and labor, repair costs split 50-50

1.Assume remaining cost, excluding fuel and labor, are equal to 75 percent of custom rates

$24/acre x 75% = $18/acre

2.Al’s ownership share is 50%. Half the total acres is 750. Al uses the combine on 1,000 acres; 250 more than half the total

3.Al pays Chris $18 for extra acres of use

$18 x 250 acres = $4,500

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Transferring Machinery Ownership

• Goals of transfer process– Reduce tax obligation for seller– Manage sales revenue for retirement– Lower cost of acquisition for buyer

• Cash flow• Economic cost

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Five Basic Transfer Methods

• Outright sale• Installment sale• Gradual sale over a period of years• Lease agreement followed by a sale• Gift

• ? Inheritance

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Example Inventory of Machinery

DescriptionCurrent Market

(sale value)Original Tax Basis

Adjusted Tax Basis

Tractor no. 1 70,000 120,000 51,456

Tractor no. 2 40,000 70,000 0

Planter 24,000 40,000 2,452

Combine 130,000 160,000 49,008

264,000 390,000 102,916

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Outright Sale• Buyer likely needs significant financing• Buyer can begin depreciating the machinery

immediately• Buyer may be able to use 179 expense

method– Bonus depreciation is only for new machinery

• Seller has income tax consequences that can be substantial– Recaptured depreciation– Capital gains

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Machinery Outright Sale – Tax Consequences

Seller

Sale Price 264,000Recaptured depreciation

161,084 * (264,000 – 102,916)Capital gain -0-

* Taxed as ordinary income. May also need to recapture 179 expense if 179 expense was used and property was not held for the entire recovery period. Thus, that portion of 179 expense taken above normal depreciation would also be subject to SE tax.

Buyer

Beginning basis 264,000Depreciation in first year

non-family sale 179 expense: 38,000 MACRS (7 yr 150%DB): 24,205 [(264,000-38,000) x .1071]

family sale 179 expense: -0- MACRS: 28,274 (264,000 x .1071)

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Installment Sale

• Seller finances the sale for the buyer• Tax consequences same as outright sale• May ease cash flow requirements of buyer• May have longer repayment terms, lower

interest rate and/or smaller down payment– May have to use IRS approved interest rate guidelines

• Machinery may depreciate faster than debt repaid

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Installment Sale – Tax Consequences

• Assets are immediately placed on buyer’s depreciation schedule

• Interest paid is a deductible expense• Seller must report all recaptured depreciation

in the first year• Sale between parties – capital gains taxed in

first year

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Machinery Installment Sale

Sale price: $264,000Terms: 4 annual payments @ 6% interest, -0- down payment

Year Principal Interest Total Balance

1 66,000 15,840 81,840 198,000

2 66,000 11,880 77,880 132,000

3 66,000 7,920 73,920 66,000

4 66,000 3,960 69,960 -0-

Seller’s tax obligation in Year 1 $161,084 recaptured depreciation, $15,840 interest income

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Gradual Sale• Selling individual machines over several years

• Spreads out tax payments as well as cash flow requirements

• Buyer is responsible for all costs for each machine as it is purchased

• Remaining equipment is leased until sold

• If buyer and seller farm together, division of income should adjust each year

• May transfer ownership when a machine needs to be replaced

• Both depreciation recapture and capital gains spread over several years

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Lease Followed by Sale• A lease differs from a rental agreement. Rental agreements

are short-term and no ownership is transferred. Rental payments are fully deductible

• Lease payments should cover depreciation, return on investment and insurance

• Economic depreciation: 8 to 10 percent of current market value

• Return on investment: 6 to 8 percent of current market value

• Lessee pays fuel, lubrication, repairs and maintenance

• Owner is responsible for capital improvements

• Lease payments should decrease as machinery line ages25

Lease: Tax Consequences• Lease payments are regular income to owner

• Lease payments are deductible for lessee

• Machinery remains on owner’s depreciation schedule

• To be a true lease agreement:

– A purchase at end of lease must be an option

– Sale price must be fair market value at that time

– Lease payments must reasonably reflect the value of the machinery

• If these conditions are not met, IRS will treat it as an installment sale

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Gifting

• Financially advantageous for recipient

• May be a financial burden to the gifter

• Consider other family members

• Tax basis transfers to recipient

• $13,000 of gifts annually may be excluded from federal gift tax

• May combine sale with gifting

• Difference between fair market value and cash paid is considered a gift

• Must be well documented

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Program Administration• Collaborated local sponsors

– They helped with meeting locations and refreshments

• State Coordinator– Willie Huot, NDSU Extension agent, Grand Forks County

• Used interactive video for presentations to each site

• Also had local speakers at each site to present topics in their area of expertise

• Presented at annual Ag Lenders Conferences

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Number of Meetings and Attendees• 21 workshops at 18 locations

– 389 participants

• 4 agricultural lenders conferences– 282 attendees

• 1 farm management class (NDSU)– 35 students

• 2 other meetings– 64 people

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North Dakota Farm Transition Meetings 2010-2011

Workshops Ag Lenders Conf Farm Mgmt Class Other Mtgs

Make-up of Workshop Attendees• Some were previous participants in Annie's

Projects

• Families with exiting producers and beginning producers attended

• Majority attended as couples

• All were active producers31

Evaluation

• 98% increased there knowledge of topic presented

• 95% increased their confidence in developing or improving as estate plan

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Transition Education is Ongoing

• Need for more educational meetings

• Average farmer age is increasing

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Take Away Points

• Need for further transition education– Transition will effect every producer at some point

• Interactive video was cost effective• Local presenters worked well with the video

– Participants wanted an in-person presenter

• Transition planning is a personal issue for most– Participants may not want to ask questions about

their specific circumstances in a public setting

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Thank You!

Any Questions?

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Acknowledgments:William Edwards, Iowa State Univ.Don Hofstrand, Iowa State Univ.

Contact Information:Ron Haugen 231-8103ronald.haugen@ndsu.eduDwight Aakre 231-7378dwight.aakre@ndsu.edu