Tax Considerations of Farm Transfers Philip E Harris

Tax Considerations of Farm Transfers Philip E. Harris Center for Dairy Profitability Department of Agricultural and Applied Economics University of Wisconsin-Madison/Extension

Alternatives for transferring farm assets p. 1 1. 2. 3. 4. 5. Sale Gift Transfer at death Trade Transferring to a business entity

Taxes imposed on farmers p. 1 1. 2. 3. 4. 5. 6. 7. Property taxes Sales taxes Employment taxes Self-employment tax Income taxes Gift taxes Death taxes

Sale p. 1 • No gift or death tax consequences • But there are income tax and self-employment tax consequences

Example 1: Land p. 1 Sale Price $295, 000 Basis 11, 800 Gain $283, 200

Example 2: Cows pp. 1 -2 Sale price of cows Income tax basis Gain $130, 000 0 $130, 000

Example 3: Machinery Sale price Basis Gain $58, 934 - 8, 434 $ 50, 500 p. 2

Character of gain or loss p. 2 • Ordinary income (10% - 39. 6%) • Capital gain (0% - 28%) • Self-employment income (15. 3%) (13. 3% for 2011 and 2012)

Example 4 p. 2 Gwen’s wages Dale’s SE income Wage base SS tax rate SS tax $100, 000 $175, 000 $113, 700 12. 4% $ 14, 099

Example 4 p. 3 SE income $175, 000 Medicare rate × 2. 9% SE income $175, 000 Threshold – 150, 000 Excess $ 25, 000 Addtnl rate x 0. 9% Total Medicare tax $ 5, 075 225 $5, 300

Three categories p. 3 1. Subject to ordinary tax rates and to self-employment tax

Example 5 p. 3 • Gain from calves is subject to income tax and SE tax • Gain from sale of heifers and cows is not in this category

Three categories p. 3 1. Subject to ordinary tax rates and to self-employment tax 2. Subject to ordinary income tax rates but not SE tax a. Depreciation recapture b. Young breeding stock

Example 6 p. 3 All of the gain on the sale of the machinery is treated as ordinary income because it was all a result of depreciation

Example 7 p. 4 Heifers that are younger than 24 months fall into this category

Three categories pp. 3 -4 1. Subject to ordinary tax rates and to self-employment tax 2. Subject to ordinary income tax rates but not SE tax 3. Capital gain or ordinary loss

Example 8 p. 4 Gain on house Loss on shed Loss on barn Gain on land Net gain $ 120, 000 - 2, 000 - 5, 000 48, 000 $ 161, 000

Example 8 p. 4 Gain on house Loss on shed Loss on barn Gain on land Net loss $ 0 - 2, 000 - 5, 000 $ - 2, 000

Net investment income tax pp. 4 -5 Beginning in 2013 there is a 3. 8% tax on net investment income but only if AGI > $200, 000 ($250, 000 MFJ; $125, 000 MFS)

Example 9 pp. 4 -5 AGI without sale $50, 000 Net investment income $5, 000 Gain from sale $161, 000 AGI with sale $211, 000 Threshold 200, 000 Excess $ 11, 000 Net inv. inc. tax ($5, 000 x 3. 8%) $190

Installment sale p. 5 Gain is reported as payments are received Example 10: $28, 320 of gain in each of 10 years

Transfer by Gift p. 5 • Gift tax consequences • Income tax consequences

Federal Gift Tax pp. 5 -6 • Annual exclusion: $14, 000/year • Marital deduction: unlimited • Lifetime exclusion: 2002 - 2010: $1, 000 2011: $5, 000 After 2011: $5, 000 (indexed)

Example 14 p. 6 Value of gifts Annual exclusion Taxable gift Gift tax Applicable credit Gift tax due $ 575, 000 - 26, 000 $ 549, 000 $ 173, 930 - 1, 730, 800 $ 0

Federal and Wisconsin Income Tax pp. 6 -7 Generally, donor’s income tax basis is carried over to donee. • Exceptions: – FMV < Donor’s basis – Gift taxes due

Example 15 Value of land Carryover basis p. 7 $295, 000 $ 11, 800

Transfer at Death p. 7 • Estate tax consequences • Income tax consequences

Federal estate tax p. 7 Years 2006 -2008 2009 2010 -2011 After 2011 Exclusion $2, 000 $3, 500, 000 $5, 000, 000(indexed)

Example 16 p. 7 Value of estate Lifetime gifts Total Tax on $ 5, 014, 550 Applicable credit Federal estate tax $4, 439, 500 549, 000 $5, 014, 550 $1, 735, 893 - 1, 730, 800 $ 5, 893

Marital Deduction p. 7 Any amount passing to surviving spouse is deducted from the taxable estate.

Wisconsin Estate Tax p. 8 Wisconsin estate tax expired at the end of 2007.

Federal and Wisconsin Income Tax p. 8 • Assets passing at death receive an income tax basis equal to the date-of-death value. • Both halves of marital property get a date-of-death value basis.

Federal and Wisconsin Income Tax p. 8 For deaths in 2010, if the executor elected out of the estate tax, assets get a carry-over basis. – But, by election, • $1, 300, 000 is added • $3, 000 is added

Example 18 p. 8 Asset Dale’s Feed 0 Cattle 7, 000 Mach. 8, 434 House 37, 500 Land 60, 000 Total 112, 934 Gwen’s After 0 23, 550 7, 000 188, 400 8, 434 117, 868 37, 500 175, 000 60, 000 750, 000 112, 934 1, 254, 818

Trade p. 9 If farm assets are traded for “like-kind” assets, gain or loss is rolled over into the acquired property.

Example 20 Trade-in value Basis in tractor Realized gain Boot Basis in planter p. 9 $25, 000 - 2, 000 $23, 000 $15, 000 $17, 000

Transferring to a Business Entity p. 10 Assets can be exchanged for ownership in an entity without triggering recognition of gain

Example 24 p. 10 • Grandpa owns 42% of LLC • Dale owns 58% of LLC

Example 26 p. 11 Sale price of 20% $ 73, 100 Grandpa’s basis 0 Grandpa’s gain $ 73, 100

Example 27 p. 11 Value of 20% interest Annual exclusion Taxable gift $ 73, 100 - 28, 000 $ 45, 100

Questions?