With all of the talk about slowing sales of farm machinery in the year ahead, farm equipment dealers and manufacturers could use some good news. The senate’s approval of the Tax Extender Bill earlier this week provided just that, if only temporarily.
The bill will extend tax breaks through Section 179 and reinstates the deduction limits to $500,000 for purchases in 2014 as it did last year, if the president signs it as he’s expected to do. Unfortunately, it only covers the current year and this whole scenario will need to be played out again next year. But we’ll take whatever we can get at the moment.
Most people in the industry agree that the availability of Section 179 deductions and bonus depreciation will, without a doubt, help year-end sales of farm machinery.
Darrel Good, professor emeritus with the Dept. of Agriculture and Consumer Economics and the University of Illinois says the passage of Section 179 could move the needle for some farmers to make big purchases yet this year.
In an interview for Ag Equipment Intelligence’s Dec. 19 “On the Record” videocast, Good said, “If they were going to make some last minute machinery or equipment purchases this year, this will kind of push them over the hump and encourage them to do that. I think that helps with their attitude as well.”
But what if it didn’t pass? What impact would it have on farm equipment sales?
As we wrote in a special report that appeared in the Sept. 2013 issue of Farm Equipment, (“How Special Depreciation Rules Impact Farm Equipment Purchases”) “Money in their pocket entices farmers to upgrade their equipment; generous depreciation allowances simplify their decision.”
In that special report, Steven Fisher, machinery analyst at UBS Investment Research, explored the subject of life without Section 179 deductions.
According to Fisher, buying a new or used $200,000 tractor with a Section 179 depreciation allowance requires about $50,000 less in cash up-front vs. buying a tractor without a significant Section 179 depreciation allowance. “We believe removal of the Section 179 benefit would cause material delays in the purchases of new or used machinery,” he said.
According to Fisher, Section 179 provides two benefits. First, it reduces the year 1 cash outflow by providing a large tax deduction in the year a tractor is placed in service. This is convenient as it largely offsets the impact of higher cash outflows for a down payment. Second, it provides a time value of money benefit as it provides greater depreciation in the first year of ownership, offset by lower depreciation — and possible depreciation recapture — in later years.
|Income Tax Effects for Purchase|
|Year||Section 179 Depreciation||MACRS Depreciation||Repair Costs||Interest on Loan||Recaptured Depreciation||Net Tax Saving|
|2011||$200,000||$ —||$ —||$(9,600)||$69,168|
Source: UBS estimates, Iowa State Extension and Outreach *The Modified Accelerated Cost Recovery System (MACRS) is the current tax depreciation system used in the U.S. Under this system, the capitalized cost (basis) of tangible property is recovered over a specified life by annual deductions for depreciation.
In the accompanying table, UBS analysts lay out two scenarios: one shows the impact of the Section 179 depreciation as it currently stands. The second scenario illustrates the same purchase decision, but with a much lower deduction limit.
In the first scenario, a $200,000 tractor is purchased on Jan. 1, 2011 and held for 3 years, before being sold for $110,000. As the $200,000 is below the $500,000 deduction limit for Section 179, the entire cost of the tractor can be deducted in year 1.
Fisher explains that, in this case, the excess of the sale price over the book value of the asset is “recaptured” at the marginal tax rate, 33% in UBS’s simplified assumptions. As the book value is $0, the recaptured tax liability is significant.
In the second scenario, a much lower Section 179 deduction limit is applied ($25,000 if the Tax Extender had not past) and no bonus depreciation allowance is available. A $200,000 tractor is purchased on Jan. 1, 2014, and held for 3 years before being sold for $110,000.
As only $25,000 of the total $200,000 purchase price can be deducted immediately, the remaining cost basis is depreciated using MACRS 150% declining balance methodology. The excess of the sale price over the book value of the asset is “recaptured” at the marginal tax rate of 33%.
Fisher noted the total net tax savings for Tractor 1 between 2011 through 2013, and Tractor 2 from 2014 through 2016, are identical at $37,913. The benefit of Section 179, he says, is it significantly reduces the total cash outflow in 2011, the year in which the down payment is made. It also has a time value of money component, as cash flows under Section 179 are frontend loaded.
In other words, if the farmer is facing a significant tax burden in a particular year when a generous Section 179 is available, for obvious reasons, he is more likely to buy capital equipment rather then wait until the next year to make the purchase.