A sale of farm machinery and equipment may cause unexpected tax consequences. The general rule is the same as for other assets. "The difference between the selling price and the property's 'income tax basis' is fully taxable." However, there are some additional rules that are probably best illustrated with a simple example:
Machinery Cost $ 30,000 - Depreciation 20,000 = Adjusted Basis $ 10,000
This farmer bought a machine for $30,000. He has taken $20,000 in depreciation, leaving an adjusted basis of $10,000. Further assume that the current "fair market value" of this machinery is $22,000.
If this farmer sells this machine for $10,000 there is no taxable gain, because the sales price and adjusted cost basis are equal. However, there is a gift of $12,000 because the fair market value of the tractor is $22,000.
If the farmer sold the tractor to one person, the result is a $12,000 gift to that person, and the farmer must file an IRS gift tax return reporting the gift. There is no gift tax unless the farmer has already used up the $600,000 unified credit (discussed earlier), but the farmer must file Form 709. If the farmer gave it to two people, such as a daughter and son-in-law, each received $6,000, and no gift tax return is required.
If the farmer sells the machine for $22,000, there is a $12,000 gain (sales price $22,000 minus $10,000 basis). The $12,000 gain is fully taxable. The income has some additional characteristics that apply to machinery, equipment and similar property.
First, the $12,000 gain is all taxable in the year of sale, regardless of the down-payment and payment schedule. Gain, due to depreciation previously taken, is fully taxable in the year of sale for most machinery, equipment and other personal property. The $12,000 is added to the other income on the seller's income tax return that year.
That may not cause problems when you're selling one tractor, but it can come as a real surprise when you are selling a whole line of machinery at much more than its book value. All the gain is taxable in the year of sale. Additional rules apply if you sell it for more than you paid for it.
Gain from the sale of farm machinery is not "farm income" for determining whether you must file "estimated income tax." You are not required to file estimates if 2/3 of your total gross income is from farming in the current or prior year. If less than 2/3 of your income is from farming, you fail the 2/3 income test in the year of sale. If you didn't meet the 2/3 test in the previous year, you may incur penalties and interest for not filing estimates. The rules and tests are not simple, so talk with a professional to check about these and other implications before entering into a sale.
Gain from the sale of farm machinery is not self-employment income for Social Security purposes. The gain is not subject to self-employment (Social Security) tax. It is not earned income and therefore does not reduce the amount of social security received by the seller.