Ag Connection
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Volume 5, Number 11
November  1999
 

 

This Month in Ag Connection

 


wpe2.jpg (5310 bytes)

Gains Subject to Recapture at Ordinary Income (General Rules)

Section 1245 Property – personal property used in a trade or business and is subject to allowance for depreciation. Gain on Sec. 1245 property is recaptured as ordinary income up to the amount of the depreciation which had been claimed on the asset(s).

Section 1250 Property – real property used in a trade or business and for which an allowance for depreciation is available. Depreciation claimed in excess of straight-line depreciation is subject to recapture at ordinary income tax rates.

Section 1252 – provides for the recapture as ordinary income some or all of the gain from the sale of land on which soil and water conservation expenses have been deducted within the last 9 years. Recapture up to the amount of gain is dependent on time elapsed from expenditure to date of sale:

diamond_.gif (84 bytes) Less than 5 years 100% recapture

diamond_.gif (84 bytes) 5 to 6 years 80%

diamond_.gif (84 bytes) 6 to 7 years 60%

diamond_.gif (84 bytes) 7 to 8 years 40%

diamond_.gif (84 bytes) 8 to 9 years 20%

(Author: Parman Green, Farm Management Specialist)

My Creditor Wants What?? The FINPACK Solution
Liquidation Taxation
You've Separated Non-GMO -- What's Next?
Gains Subject to Recapture at Ordinary Income Rates (General Rules)
Special Financial Management Insert

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My Creditor Wants What??  The FINPACK Solution

Many creditors are requiring more financial information on your farm business. In addition to the usual information, you may be required to do a projected cash flow for the year 2000 and future years. FINPACK (Financial Package) is a comprehensive financial planning and analysis system designed to help farmers understand their financial situation and make informed decisions. This software includes three modules: long-range financial planning, cash flow projection and business analysis.

FINPACK is not a record-keeping system. Instead, it provides a tool to effectively use your farm records to make business analysis, long-range planning, and cash flow planning as complete, easy and meaningful as possible. With your 2000 farming plan and your records, an Extension Farm Management Specialist can help you understand preparation of the projected cash flow.

FINPACK helps you analyze your current situation (Where am I?); the long-range potential of alternative strategies (Where do I want to be?); and the cash flow implication of moving from where you are to where you want to be (How can I get there and can I afford it?). Even if you are not planning a major change, FINPACK provides tools to make sense of your financial records and to plan cash flows accurately for future years.

Complete and accurate data on your farming operation is essential for you to benefit from FINPACK programs.

blueball.gif (303 bytes)  The starting point is an accurate balance sheet.

blueball.gif (303 bytes)  On the farm assets side, individual, corporation, quantity and livestock numbers and weight must be included.

blueball.gif (303 bytes)  On the liabilities side, loans need to be broken into categories: current, intermediate, and long term.

blueball.gif (303 bytes)  Interest rates and payment schedules are needed.

FINLRB (Financial Long Range Budgeting) compares the long-range profitability and debt repayment ability. For growth in net worth of present plan or alternative farm plans FINLRB addresses the question: "Where am I and where do I want to be?"

FINFLO (Financial Cash Flow) projects cash inflow and outflow for each month of the planning year based on your production, marketing, and financial plan. FINFLO projects the timing of cash flow and credit needs during the year.

For more details contact your Extension Farm Management Specialist.

(Author: Bill Buehler, Farm Management Specialist)


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Liquidation Taxation

The current farm economy is forcing several farm managers to consider the liquidation of some assets or in some extreme cases -- the entire business. Disposal of farm business assets can involve several different types of income (gain or loss).

For example, a farmer purchased a combine in 1998 for $165,000 and financed $150,000 of the cost through XYZ Equip. Company. The farmer claimed the maximum Section 179 (expensing election) deduction of $18,500 and $15,690 of regular depreciation on the 1998 income tax return. This gives a tax basis in the asset of $130,810 ($165,000-$18,500-$15,690). In 1999 with little prospects for any substantial fall grain harvest, the farmer talked the XYZ Equip. Co. into accepting the combine back in exchange for the complete discharge of the $150,000 principal balance on the note. At the time the combine was returned, its fair market value was $140,000. What are the tax consequences of this transaction?

Return of Basis $130,810 Non-taxable
Gain (FMV – Basis) $  9,190 Section 1245 Gain (recapture of depreciation)
Discharge of Debt $ 10,000 Debt – FMV

The Section 1245 asset depreciation recapture and discharge of indebtedness are reported as ordinary income. However, since the discharge of debt involves farm debt, the farmer may reduce existing tax attributes such as net operating loss carryover, tax basis in other farm equipment, the tax basis of farmland – in that order. Note – the only means of realizing a capital gain tax rate on the sale of purchased farm equipment is if the item is sold for more than its original cost.

The following is a graphical presentation for analyzing this type of transaction.

 

Example

Your Figures

Original Cost

$165,000

 
Debt Discharged

$150,000

 
Discharge of Indebtedness Income    
Fair Market Value

$140,000

 
Gain (May be subject to capture of depreciation)        
Tax Basis        
Return of Basis In Asset

$130,000

 

Major Planning Points For Liquidation of Assets

1. Ordinary income versus capital gain
Will gains from the liquidation of assets generate capital gains or ordinary income?

2. Recapture of depreciation
Sec. 1245, 1250, and 1252 gains may generate substantial amounts of ordinary income.

3. Unrecaptured Section 1250 gain
The 1997 Tax Act created a 25% max. tax bracket for any unrecaptured Sec. 1250 gain.

4. Sale of residence
For all practical purposes, the gain on the sale of the main home can be tax free.

5. Weather related sales of livestock
This year’s weather may have caused excessive sales of livestock. Tax provisions are available for deferment of gain or future replacement of livestock.

6. Deferred (like-kind) exchanges
With proper planning and action, replacement of property within 180 days will be treated as a non-taxable like-kind exchange.

7. Farm income averaging
Average over prior 3 years. Generally includes all farm income, except gain from sale of land.

8. Alternative minimum tax (AMT)
A second recalculation of tax liability, taxpayer is required to pay the higher of regular tax or AMT. Some tax preference items not recognized as income for regular tax are recognized as income for AMT.

9. Discharge of indebtedness
The forgiveness of debt is considered the same as income. Reduction of tax basis can offset this item if a complete liquidation is not involved. However, this can be a real cash flow trap in a complete liquidation.

10. Bankruptcy
Don’t ride a dead horse too long. With proper planning and action, bankruptcy (complete or reorganization) may offer the best alternative.

(Author: Parman Green, Farm Management Specialist)


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wpe2.jpg (3174 bytes)You've Separated Non-GMO -- What's Next?

Few elevators have separated GMO (genetically modified organism) grains from non-GMO grain. However, many of the elevators and grain processors have encouraged farmers to segregate non-GMO grain. This suggests that non-GMO grains were separated and stored on the farm to capture any premiums that might later be offered. If you had the bins to do this and have separated your non-GMO grain, what do you do next?

A lot has been said about consumers wanting non-GMO products, with very little indication of what they are willing to pay to get them.    According to market theory, consumer desires are communicated to producers through market demand expressed by price. Some consumers have cited safety concerns about GMO products and the desire for non-GMO products. But, with no known GMO safety hazards, how strong is the demand for non-GMO products—especially if they cost more? This may limit premiums.

In addition to demand, price premiums will depend on the supply of non-GMO grain. It has been estimated that 35% of the 1999 corn crop and 55% of the soybean crop was planted with GMO seed. Additionally, cross-pollination and mixing of GMO and non-GMO has occurred. While it might appear that plenty of non-GMO grain is available, the supply really depends upon how many have kept it separate.

Price premiums should cover the cost of keeping the grain separate. If you’ve stored non-GMO separately, you should expect something for your effort. There will be additional costs to keep it separate until it reaches the consumer.

Since few elevators have segregated grain, in order for you to market it, they will have to "gear up" to segregate non-GMO or you will have to truck it (likely by semi) to someone who can. The grain will have to be kept separate in trucks, trains and barges. Exported grain will also have to be shipped separately. This all costs extra and there are always risks of contamination at some point in the process. Ultimately, the premiums will have to cover these additional costs and risks.

The question of risk is another factor that you need to be aware of if you’ve segregated non-GMO grain. Standards are essentially non-existent and testing will be limited, so processors and handlers will rely heavily on certification. Be careful about what you certify, the documents you sign or any oral commitments that you make. Other liabilities exist in the form of implied warranties. Implied warranties state that goods sold are fit for the use the buyer intends and this might apply to farmers as sellers.

You’ve separated and stored non-GMO grain, but you aren’t finished yet. You still have to market it! Non-GMO grain marketing and handling is similar to any other specialty or identity preserved product. Be prepared to move quickly; premiums are uncertain and likely to be variable and spotty unless you have a specific contract.

(Author: Melvin Brees, Farm Management Specialist)

If producers are asked by the first purchaser to promise that the crop is non-GMO, they should be very careful what they sign or what oral comments are made.

Here's what producers can realistically do.

clover_b.gif (93 bytes) State that no seed represented by the Seed Company as GMO seed was planted.

clover_b.gif (93 bytes) State that seed represented by the Seed Company as non-GMO seed was planted.

clover_b.gif (93 bytes) State that care was taken in avoiding contamination in bins, auger and in the combine.

Here's what producers should be careful not to do.

clover_b.gif (93 bytes) State that the crop in question has no GMO germ plasm.

clover_b.gif (93 bytes) State that no contamination has occurred from mechanical handling and storage of the crop.

clover_b.gif (93 bytes) State that no contamination has occurred from pollen drift.

(Source: Neal E. Harl, Iowa State University)

For more information see:
Economic Perspectives on GMO Market Segregation, Iowa State University


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University of Missouri ExtensionAg Connection - November 1999
http://outreach.missouri.edu/agconnection/newsletters/is-99-11.htm -- Revised: April 20, 2004
daydr@missouri.edu