Tax Consequences of Liquidation of A Farming Business

1. Tax Consequences of Liquidation of A Farming Business Tina Barrett Executive Director Nebraska Farm Business, Inc.

2. Nebraska Farm Business, inc.

3. Mission of NFBI

4. Financial analysis

5. Nebraska Income Trend Net Farm Income 1985 - 2000

6. Nebraska Income Trend Net Farm Income 1985 - 2007

7. Net Income trend Change

8. Net Income trend Change Higher profitability of the past few years has led to:

9. Net Income Trend Change Leads to:

10. Farm Income Understanding Different Types of Income From a Farming Operation.

11. Farm Income Types

12. Inventory Income Schedule F Income • Grain • Livestock • Feeding Livestock (Raised or Purchased) • Receivables • Government Farm Payments • Custom Work • Insurance Income • Offset By Ordinary Farm Expenses • Seed, Fertilizer, Fuel, Interest, etc.

13. CAPITAL Income Schedule D Income • May Flow Through From Form 4797 • Raised Breeding Livestock • Held more than 1 year • Cattle and Horses – Must be held 24 months • Farmland • Held more than 1 year • Income only when sale price exceeds basis * * Basis explained fully later.

14. Depreciation Recapture

15. Understanding Basis • Asset Purchased • Place asset on depreciation • Option 1: Place on a life class schedule (3, 5, 7 years, etc) • Option 2: Elect Section 179 (Expense Election) to write off the cost in the year purchased • Option 3: Elect Bonus Depreciation in year of purchase (not always available) • Non-Depreciable Assets • Land • Raised Breeding Livestock • Cost of raising is usually deducted on Schedule F as ordinary business income.

16. Understanding Basis • Original Basis = Original Purchase Cost • Current Basis = Original Purchase Cost - Depreciation • If a tractor was purchased and Section 179 was elected to write off the purchase cost, the basis of that tractor is $0 the first year.

17. Depreciation Recapture Tractor • Original Cost • Depreciation Taken • Remaining Basis • Selling Price • Gain (Depreciation Recapture) $100,000 - $75,000 = $25,000 $70,000 $45,000

18. Depreciation Recapture • Gain is Depreciation Recapture because the gain is less than the depreciation taken. • If the gain was more than the depreciation taken, a capital gain would be triggered.

19. Depreciation Recapture • Tractor • Original Cost • Depreciation Taken • Remaining Basis • Selling Price • Gain • Depreciation Recapture • Capital Gain $100,000 - $75,000 = $25,000 $110,000 $85,000 $75,000 $ 10,000

20. Depreciation Recapture • Usually hard to generate a capital gain on the sale of farm equipment. • Must sell the asset for more than it was purchased for. • More common in recent years in purchased breeding livestock.

21. Debt Forgiveness • Debt Forgiveness IS taxable • Except for… • Insolvency • Qualified Farm Debt • Qualified Real Property Business Debt • Qualified Principal Residence Debt

22. Debt Forgiveness • Insolvency • Must have Negative Net Worth • To the extent you are insolvent – debt forgiveness is not taxable. • Example: • Your net worth = $-250,000 • Debt Forgiveness = $200,000 • No taxable income

23. Debt Forgiveness • Insolvency • Must reduce tax attributes in specific order • Includes Net Operating Loss • Example: • Same as previous, but Debt Forgiveness = $400,000 • NOL = $200,000 • 1st $250,000 is erased by insolvency • $150,000 reduces NOL • No tax due, but less to offset other income.

24. Tax attributes • Net Operating Losses (NOL) • General Business Credit Carryover • Minimum Tax Credit • Capital Loss • Basis • Real Property (Land, Buildings) • Personal Property (Equipment) • Other Property (Non-Inventory Assets) • Passive Activity Loss and Credit Carryovers • Foreign Tax credit

25. Tax attributes • Qualified Farm Indebtedness Changes Order of #5. • Basis • Personal Property (Equipment) • Real Property (Land, Buildings) • Other Property (Non-Inventory Assets)

26. Net operating Losses • Created when Adjusted Gross Income (generally) is negative. • A negative Schedule F does not necessarily make a NOL. Losses must be greater than all other income sources. • Can be carried back 2, 3 or 5 years (only farm losses are eligible for 5 years) • Or, you can elect to carry forward until used up. • If a farm is in a forced liquidation, the losses will most likely be carried forward as there is likely no income in the past.

27. Tax Treatments

28. Tax Costs

29. Life Cycle of A Farm

30. Life Cycle of a Farm

31. Life Cycle of a Farm

32. Example: Will E. Farmer

33. Will E. Farmer Liquidation • Inventory Sale • $250,000 • Equipment Sale • $350,000 Sale Price • $150,000 Basis • Land Sale • $500,000 Sale Price • $200,000 Basis • Net Operating Loss Carryover • $250,000 * Tax Costs Are Estimates Only

34. Will E Farmer Liquidation • Ways to Avoid Large Tax Bill • Liquidate Inventory in loss years • Avoids SE tax & NOLs • Use “normal” depreciation • Especially when financing the purchase • Allows basis write off to equal debt reduction

35. Tax Consequences Of Liquidation of A Farming Business • Conclusions: • Without multiple years of planning, the liquidation of a farm has a high tax cost. • Inventory income (sale of grain, feeding livestock, etc) will cost the most – highest percentage of tax. • Capital income (sale of land, raised breeding livestock) will be the cheapest tax. • Debt forgiveness will most likely be taxable.