Transferring Ownership of Farm Machinery

Transferring Ownership

of Farm Machinery

File A3-32

PM 1450 Revised August 2013

Ag Decision Maker

arm machinery is an important com-

ponent of transferring ownership (In-

formation File Business Ownership

Transfer Process) from the older party to the

younger party. The use and ownership of farm

machinery can be transferred from the older

party (seller or giver) to the younger party

(buyer or recipient) immediately or over sev-

eral years.

Five basic transfer methods are available:

• outright sale,

• installment sale,

• gradual sale over a period of years,

• lease agreement followed by a sale, and

• gift.

Each method has different ﬁ nancial and in-

come tax consequences.

The methods of transferring machinery own-

ership outlined in this section are illustrated

by using examples. These examples are based

on the four machines listed in Example 1 with

a total current market value of $264,000 and

income tax basis of $102,916.

In all cases, a value must be placed on each

piece of equipment at the time it will be trans-

ferred. A machinery dealer or auctioneer may

be willing to make an appraisal for a fee. List

each item as it appears on the

seller’s depreciation schedule

and the value that is agreed

upon.

Outright Sale

An outright sale occurs when

the seller of machinery trans-

fers ownership to the buyer

immediately and is paid the

full purchase price by the buyer.

An outright sale gives the buyer complete free-

dom to use, sell, trade, or lease the machinery,

or use it as collateral for securing a loan. The

seller has no further claim to the machinery

and can spend or invest the funds received as

desired.

Financial considerations

For an outright sale, the buyer’s payment is

equal to the full agreed-on value of the ma-

chinery. A beginning farmer may ﬁ nd it dif-

ﬁ cult to generate this much cash from savings

and equity. A third party lender may be willing

to provide a loan if the machinery can serve

as collateral or if the buyer has other assets

to pledge. Beginning farmers with a small net

worth may need a co-signer for a loan. In fam-

ily situations, the co-signer may be the seller

of the machinery.

When the younger party doesn’t want to

use all savings for purchasing machinery, or

doesn’t want to go into debt, other methods

that reduce the initial ﬁ nancial obligation can

be used.

Income tax considerations

The income tax consequences of an outright

sale can be substantial, as shown in Example

Example 1. Inventory of machinery.

Description

Current Market

(sale value)

Original Tax

Basis

Last 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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Transferring Ownership of Farm Machinery

2. For the seller, a large amount of recaptured

depreciation and capital gain may arise from

the sale, especially if some assets have an ad-

justed tax basis of zero; that is, they are “de-

preciated out.” Reporting all the income and

gain in one tax year may cause some of it to be

taxed at a higher marginal rate than the seller

usually pays. In addition, most sellers prefer

to spread out or postpone tax payments when-

ever possible.

The buyer can begin depreciating the machin-

ery in the year it is placed in service and may

use the expense method depreciation allow-

ance, if eligible. Buyers who are relatively new

in farming may not have enough taxable farm

income to make use of the maximum expense

method depreciation allowance, however.

Installment Sale

An installment sale gives the buyer immediate

possession and use of the machinery, just as in

an outright sale. However, the seller ﬁ nances

the sale for the purchaser, and periodic pay-

ments are made, as shown in Example 3.

Financial considerations

An installment sale can ease the cash ﬂ ow re-

quirements for a beginning farmer by spread-

ing payments over several years. Compared

with the terms of a commercial loan, an in-

stallment sale may have a longer repayment

term, lower interest rate, and/or a smaller

down payment.

The seller, however, does not have the ben-

eﬁ t of receiving payment as quickly as with

an outright sale. In addition, the machinery

may depreciate faster than the debt is repaid,

causing the collateral value to be less than the

outstanding debt.

In an installment sale, the amount and timing

of the payments can be scheduled to match

the income stream generated by the assets. For

example, the payment for purchasing a line

of machinery may come once a year when the

crops are sold.

The payment schedule also should specify the

rate of interest to be paid on the unpaid bal-

Example 2. Machinery outright sale.

Seller

Sale price (Ex. 1): $264,000

Recaptured

depreciation (Ex. 1): $161,084

(264,000 - 102,916)

Capital gain

: $ 0

Buyer

Beginning basis: $264,000

Depreciation in ﬁ rst year:

nonfamily sale

-- expensing: $ 38,000

-- MACRS: $ 24,205

[(264,000 - 38,000) x .1071]

family sale

-- expensing $ 0

-- MACRS: $ 28,274 (264,000 x .1071)

There is no capital gain because the sale price of each

machine is below the original tax basis.

Depreciation includes section 179 expensing of

$38,000 (a larger amount could have been de-

ducted) plus seven-year class MACRS depreciation

using the 150% declining balance method.

Example 3. Machinery installment sale.

Sale price: $264,000

Term: Four annual payments

Interest: 6% on the unpaid balance

Down payment: none

Payment schedule:

Unpaid

balance

Year Principal Interest Total

Now ------ ------ ------ $264,000

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

Income tax consequences are the same as in Example 2.

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Transferring Ownership of Farm Machinery

ance. This rate can be ﬁ xed for the life of the

contract or renegotiated periodically. Family

agreements sometimes contain below market

interest rates. If the interest rate is lower than

the “applicable federal rate,” the payments

must be recalculated at the federal rate when

reporting interest for income taxes. The ap-

plicable federal rate is adjusted monthly and

can be obtained from most tax preparers or the

Internal Revenue Service (IRS).

Income tax considerations

For the buyer, the tax consequences of an

installment sale are the same as for an outright

purchase. The assets are immediately trans-

ferred to the buyer’s depreciation schedule. In

addition, interest paid becomes a deductible

expense.

The seller must report all recaptured deprecia-

tion in the year of sale, even if payments are

spread over more than one tax year. When the

buyer and seller are closely related, all capi-

tal gains (if any) also may be taxable in the

year of sale. This applies to parents, children,

spouses, and certain corporations, partner-

ships, and trusts. Check with a qualiﬁ ed tax

preparer to determine what rules apply to your

particular situation. For unrelated parties,

capital gain is taxed in the years that debt pay-

ments are made, but recaptured depreciation is

still taxed in the year of sale.

When several pieces of machinery are sold

together, the selling price is allocated among

them based on their relative fair market val-

ues. Likewise, the buyer allocates the purchase

price among the items based on relative fair

market values to obtain the beginning basis for

depreciation.

Interest is taxed as it is received. Thus, the

taxation of the payments of a sale between

related parties can be spread out somewhat

by increasing the interest rate and lowering

the purchase price of the machinery within a

reasonable margin.

Example 4. Machinery gradual sale.

Year 1 Year 2 Year 3 Year 4

Item sold (Ex. 1): tractor no. 2 planter tractor no. 1 combine

Seller

Sale price:

$40,000 $22,000 $56,000 $90,000

Adjusted basis:

0 0 $22,056 0

Recaptured

depreciation: $40,000 $22,000 $33,944 $90,000

Buyer

Beginning basis: $40,000 $22,000 $56,000 $90,000

Depreciation in ﬁ rst year:

-- nonfamily sale:

$38,214 $22,000 $39,928 $43,570

-- family sale:

$ 4,284 $ 2,356 $ 5,998 $ 9,640

Sale prices are decreased in later years to reﬂ ect wear and obsolescence.

The adjusted basis is decreased in later years to reﬂ ect the additional tax depreciation claimed.

Depreciation includes section 179 expensing at the $38,000 level (more could have been taken), plus MACRS

depreciation using the 150% declining balance method.

Depreciation is based on the MACRS 150% declining balance method. No section 179 expensing is allowed.

Page 4

Transferring Ownership of Farm Machinery

Gradual Sale

A line of machinery also can be transferred

by selling one or two items outright each year

as shown in Example 4. Such a gradual sale

can spread out tax payments as well as the

cash ﬂ ow requirements. The assets transferred

each year must be clearly speciﬁ ed. The buyer

becomes responsible for repairs, insurance,

and other ownership costs when each piece of

machinery changes hands.

A plan should be developed identifying which

items of machinery will be transferred each

year and how many years will be required to

complete the transfer. A gradual sale can con-

tinue until all the machinery is sold.

If the parties farm together, the gradual trans-

fer may change how farm income is divided

each year. The younger party will own more of

the business assets each year so should receive

a larger share of the income. If the older party

has already left the business, the younger party

will need to lease items that have not yet been

purchased.

Financial considerations

With a gradual sale, the cash ﬂ ow require-

ments are spread over a period of years, simi-

lar to an installment sale or an outright sale

ﬁ nanced by a lender. However, the gradual sale

does not require the buyer to borrow money to

buy the entire machinery line.

Another advantage of a gradual machinery sale

is that the number of items transferred can be

adjusted each year to ﬁ t the buyer’s cash ﬂ ow

situation. For example, if the younger party

has a low proﬁ t year, the number of items

purchased that year can be reduced or elimi-

nated. Conversely, the number of items can be

increased in a year of high proﬁ ts.

Some sellers elect to transfer ownership each

time a major equipment item is replaced. The

buyer can supply the down payment money

for the trade and pay the seller the fair market

value of the item traded. If co-ownership is de-

sired, the fair market value of the item traded

is counted toward the seller’s portion of the

cost of the new machine.

Income tax considerations

The tax consequences of a gradual sale are the

same as those described for the outright sale,

but occur over several years. Unlike an install-

ment sale, a gradual sale spreads both recap-

tured depreciation and capital gains over a

period of years. It also allows an eligible buyer

to use the expense method depreciation option

each year.

In addition, selling machines with the high-

est adjusted tax basis last allows the seller to

continue to depreciate them.

Leasing

A lease can be used in situations where the

owner (older party) already has left the busi-

ness. For example, if the older party leaves the

business before the machinery ownership is

transferred, the machinery can be leased until

it is purchased.

The lease payments should be reasonable and

should cover the owner’s ﬁ xed costs of depre-

ciation, return on investment, and insurance.

Tax depreciation is usually a poor estimate of

actual economic depreciation. Economic de-

preciation can be estimated by multiplying the

current market value of the machinery by 8 to

10 percent. Return on investment can be com-

puted by multiplying the current market value

by a return of 6 to 8 percent. The actual cost of

insurance can be used. Alternatively, the lease

payment can be computed by multiplying the

current market value by 15 to 20 percent.

Page 5

Transferring Ownership of Farm Machinery

The renter (younger party) is usually

responsible for all costs related to use, such

as fuel, lubrication, repairs, and maintenance.

The owner (older party) is usually responsible

for paying for capital improvements, such

as major overhauls or the replacement of an

engine. These improvements increase the

value of the machine, the rental rate, and the

eventual sale value. Rental payments should

decrease as the machinery line ages, unless

older machines are replaced.

When a machine is used by both the owner

and the renter, an agreement (Information File

Machinery and Labor Sharing Agreement) can

be created and lease payments can be calcu-

lated by the acre or by the hour. A lease ar-

rangement often is combined with one of the

methods of transferring ownership described

previously.

Lease with Option to Buy

Leasing machinery with an option to buy al-

lows the younger party to use

the equipment for a period of

years and then buy it at the

end of the lease period.

Financial considerations

Leasing a machine from the

older party can lower the

cash ﬂ ow requirements of

the younger party in the

early years, as illustrated in

Example 5. It also allows the

buyer to accumulate ﬁ nancial

resources and to be more

certain about what direction

the farming operation will

take before purchasing.

Income tax considerations

Lease payments are taxed as

they are received by the owner (older party)

and are a deductible expense to the renter

(younger party). All leased machinery remains

on the depreciation schedule of the owner. If

the option to purchase is exercised, the same

tax consequences arise as described for an

outright sale, but they are based on the sale

price at the time the option is exercised.

To be taxed as a true lease agreement, a lease

with an option to buy arrangement must allow

for the purchase at the end of the lease to be

optional, and the eventual purchase price must

be near the fair market value of the machinery

at that time. Lease payments must reasonably

reﬂ ect the value of the machinery. If the lease

does not meet IRS conditions for a lease, it will

be taxed as an installment sale.

Lease with Gradual Sale

A lease can be combined with a gradual sale

in situations where the owner (older party)

leaves the business before the sale is com-

Example 5. Machinery lease with option to buy after three years.

Year 1 Year 2 Year 3 Year 4

Value

$264,000 $238,000 $214,000 $192,000

Lease payment

$ 39,600 $ 35,700 $ 32,100

Purchase $192,000

Seller

Sale price in fourth year: $192,000 (fair market value)

Adjusted tax basis: 0

Recaptured depreciation: $192,000 (after year 4)

Buyer

Beginning basis: $192,000

Depreciation in ﬁ rst year of ownership:

nonfamily sale:

-- expensing $ 38,000

-- MACRS: $ 16,494

[(192,000 - 38,000) x .1071]

family sale

-- expensing $0

-- MACRS: $ 20,564

(192,000 x .1071)

Current value is reduced to reﬂ ect economic depreciation.

Computed at 15% of current value.

Depreciation includes section 179 expensing at $38,000, plus MACRS

depreciation using the 150% declining balance method.

Page 6

Transferring Ownership of Farm Machinery

Example 7. Machinery outright gift.

Seller

Fair market value: $264,000

Sale price: 0

Adjusted basis: $102,916

Depreciation recapture: 0

Capital gain: 0

Gift:

$264,000

Buyer

Purchase price: 0

Beginning basis: $102,916

May reduce the uniﬁ ed credit and could be subject to gift

tax.

pleted. Each year, the buyer (younger party)

purchases one or more items of machinery

and leases the machinery that has not yet

been purchased. As items are purchased, they

are dropped from the lease arrangement and

the lease payments are reduced accordingly.

Example 6 shows an example of a combined

lease and gradual sale.

Gifting

Machinery also can be transferred from the

older party to the younger party as an outright

gift.

Financial considerations

With a gift, the giver (older party) receives no

payment from the recipient (younger party) in

exchange for the machinery. Although a gift

program is ﬁ nancially advantageous for the re-

cipient (younger party), it may be a burden to

the giver (older party) if money is needed for

living expenses and other commitments. Also,

in a parent and child situation, other family

members may feel that they have not been

treated fairly unless gifts of an equal value are

made to them as well.

Income tax considerations

The adjusted income tax basis of machinery

transferred as a gift generally carries over to

the recipient’s depreciation schedule as shown

in Example 7. Gifting has the advantage of

delaying the income tax consequences of the

transfer until a later time. However, the re-

cipient (younger party) will have few or no

depreciation deductions from items with a low

adjusted basis, such as older machinery.

Gift tax considerations

Federal tax laws allow gifts of present inter-

ests of up to $14,000 (2013) annually to be

excluded from gift tax (AgDM File C4-23 Gift

Tax). The exclusion is annual so it can be used

every year (the gift tax exclusion amount may

be adjusted each year). Up to $28,000 can be

given by a wife and husband, even if only one

of them owns the property. When gifts are

made to both the gift recipient (younger party)

and his/her spouse, the amount is doubled.

So, the older party husband and wife can give

Example 6. Machinery gradual sale/lease combination.

Year 1 Year 2 Year 3 Year 4

Item sold (Ex. 1): tractor no. 2 planter tractor no. 1 combine

Sale price: $40,000 $22,000 $56,000 $90,000

Value of remaining machinery: $194,000 $152,000 $90,000 0

Lease payment (15%): $29,100 $22,800 $13,500 0

Total payment (lease plus sale): $69,100 $44,800 $69,500 $90,000

Recaptured depreciation and depreciation in ﬁ rst year are the same as for Example 4.

Page 7

Transferring Ownership of Farm Machinery

Example 8. Machinery combination sale and gift.

Seller

Fair market value: $264,000

Sale price: $200,000

Adjusted basis: $102,916

Depreciation recapture: $ 97,084

(200,000 - $102,916)

Gift:

$ 64,000

(264,000 - $200,000)

Buyer

Purchase price: $200,000

Beginning basis: $200,000

Depreciation in ﬁ rst year:

nonfamily sale

-- expensing: $ 38,000

-- MACRS: $ 17,350

[(200,000 - 38,000) x .1071]

family sale

-- expensing: $ 0

-- MACRS: $ 21,420

(200,000 x .1071)

May reduce the uniﬁ ed credit and could be subject to gift

tax.

Depreciation includes section 179 expensing at $38,000,

plus MACRS depreciation using the 150% declining

balance method.

up to $56,000 to the younger party husband

and wife without being subject to gift tax ﬁ l-

ing. Taxable gifts beyond this exclusion are

included in the calculation of federal estate

tax (Information File Federal Estate Tax) after

death and may increase the amount of federal

estate tax due.

Combination Sale and Gift

Machinery gifts can be combined with an out-

right sale. The difference between the fair mar-

ket value of the machinery and the amount of

cash paid for the machine is considered a gift.

These values should be documented carefully.

If the size of the gift is equal to or less than the

annual exclusion, no gift tax ﬁ ling is due.

Financial considerations

The combination sale and gift method reduces

the buyer’s (younger party’s) cash ﬂ ow re-

quirements. However, the seller (older party)

receives less money to spend or invest, which

could reduce ﬁ nancial security during retire-

ment.

Income tax considerations

The tax consequences of a combination sale

and gift are shown in Example 8. The lower

sale price reduces the amount of recaptured

depreciation and could lower or eliminate cap-

ital gains. However, the buyer (younger party)

will have a lower initial tax basis to depreciate

when the machinery is purchased.

Gradual Gift and Sale

Combining a gradual sale with a gifting pro-

gram is similar to a gradual sale except that

the sale price of each item is below fair market

value. The difference is considered a gift. An

advantage of this method is that the annual

gift tax exclusion can be used every year.

Financial considerations

In addition to spreading the purchase cost over

several years, it also reduces the size of the

payment each year. However, the seller (older

party) receives less cash, which may negatively

impact his/her ﬁ nancial position during retire-

ment.

Some gradual sale and gift agreements specify

that when a machinery item is replaced, the

item to be traded is gifted to the younger party

who then supplies the cash difference needed

to complete the trade.

Page 8

Transferring Ownership of Farm Machinery

Income tax considerations

The income tax consequences of this method

are shown in Example 9. The value of the gift

reduces the sale price of each machine, which

reduces the amount of recaptured deprecia-

tion. However, the initial basis and amount of

depreciation that can be claimed by the buyer

also is reduced.

… and justice for all

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Issued in furtherance of Cooperative Extension work, Acts of May 8 and June 30,

1914, in cooperation with the U.S. Department of Agriculture. Cathann A. Kress,

director, Cooperative Extension Service, Iowa State University of Science and

Technology, Ames, Iowa.

Prepared by William Edwards,

emeritus economics professor

[email protected]

and Don Hofstrand,

retired extension ﬁ eld specialist

Example 9. Machinery gradual combination sale and gift.

Year 1 Year 2 Year 3 Year 4

Item sold (Ex. 1): tractor no. 2 planter tractor no. 1 combine

Seller

Market value:

$40,000 $22,000 $56,000 $90,000

Sale price:

$24,000 $12,000 $36,000 $50,000

Adjusted basis:

0 0 $22,056 0

Depreciation recapture: $24,000 $12,000 $13,944 $50,000

Gift:

$16,000 $10,000 $20,000 $40,000

Buyer

Purchase price: $24,000 $ 12,000 $36,000 $50,000

Depreciation in ﬁ rst year:

-- nonfamily sale:

$24,000 $ 12,000 $36,000 $39,286

-- family sale: $ 2,570 $ 1,286 $ 3,856 $ 5,356

Market values are reduced in later years to reﬂ ect wear and obsolescence.

Adjusted basis is decreased in later years to reﬂ ect the additional tax depreciation claimed.

Equal to market value minus sale price. May reduce the uniﬁ ed credit and be subject to gift tax.

Depreciation includes section 179 at $38,000, plus MACRS depreciation using the 150% declining balance method.

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