Machinery Sharing, An Option In Farm Transition Ron Haugen North Dakota State University Extension Service 8/28/ National Women in Agriculture Educators Conference Memphis, Tennessee March, 2012

2 Acknowledgments: William Edwards, Iowa State University Don Hofstrand, Iowa State University Dwight Aakre, North Dakota State University Willie 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 3

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 more 4

2007 Census of Agriculture

Machinery Sharing and Transfer of Ownership March 2012 Ron Haugen Farm 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 7

Joint Ownership (formal agreements) Written agreement When and how to determine use How to dissolve agreement How to determine value at dissolution 8

Why Joint Ownership? Lower cost of ownership Have use of newer technology Labor benefits Less capital needed to get started 9

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 10

Unequal Use Al and Chris purchase a combine together Al 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 11

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=$28,000 Chris - $28/acre x 500 acres= 14,000 $42,000 12

Example 1 2. The following expenses are paid from the account: Fuel and lubrication$ 7,200 Repairs and maintenance4,500 Labor $12) Paid to Al: 300 hours3,600 Paid to Chris: 150 hours1,800 Depreciation, interest, insurance and housing (16% of value of combine) Paid to Al12,000 Paid to Chris12,000 $ 41,000 13

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$42,000 Costs 41,000 Excess $1,000 14

Example 2 Partner with most acres reimburses other owner for extra use. Al and Chris own combine Al harvests 1,000 acres; Chris 500 acres Both furnish their own fuel and labor, repair costs split 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 15

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 16

Five Basic Transfer Methods Outright sale Installment sale Gradual sale over a period of years Lease agreement followed by a sale Gift ? Inheritance 17

Example Inventory of Machinery Description Current Market (sale value) Original Tax Basis Adjusted Tax Basis Tractor no. 1 70,000120,000 51,456 Tractor no. 2 40,000 70,000 0 Planter 24,000 40,000 2,452 Combine130,000160,000 49, ,000390,000102,916 18

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 19

Machinery Outright Sale – Tax Consequences Seller Sale Price 264,000 Recaptured depreciation161,084 * (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 basis264,000 Depreciation 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) 20

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 21

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 22

Machinery Installment Sale Sale price:$264,000 Terms:4 annual 6% interest, -0- down payment YearPrincipalInterestTotalBalance 166,00015,84081,840198, ,00011,88077,880132, ,000 7,92073,92066, ,96069, Seller’s tax obligation in Year 1 $161,084 recaptured depreciation, $15,840 interest income 23

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 24

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 ages 25

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 26

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 27

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 28

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 29

30 North Dakota Farm Transition Meetings Workshops Ag Lenders ConfFarm 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 producers 31

Evaluation 98% increased there knowledge of topic presented 95% increased their confidence in developing or improving as estate plan 32

Transition Education is Ongoing Need for more educational meetings Average farmer age is increasing 33

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 34

Thank You! Any Questions? 35 Acknowledgments: William Edwards, Iowa State Univ. Don Hofstrand, Iowa State Univ. Contact Information: Ron Haugen Dwight Aakre