The Tax Cuts and Jobs Act passed in December 2017, commonly referred to as the Tax Reform Act, eliminated the ability of taxpayers to defer taxable gains on personal property used in a business when exchanged for “like-kind” property. The new rules apply to exchanges completed after December 31, 2017, although transition rules can apply in certain situations to alter that date.
This exchange technique was commonly known as a “like-kind exchange” and was used heavily by ag producers and farm equipment dealers when old equipment was traded-in for new. The federal tax impact of eliminating the like-kind exchange treatment on personal property was relieved through two other new tax law changes:
The accelerated tax deduction now afforded by bonus depreciation and Section 179 typically offsets any gain required to be recognized on the trade-in value received for equipment during a trade. This means the result of the elimination of like-kind exchange eligibility to ag producers is either a tax liability neutral change or even a tax liability reduction, depending on the trade differential paid on the new unit for federal tax purposes.
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While the federal law is proving beneficial, the same cannot be said for Minnesota taxpayers, resident or non-resident. The Minnesota Department of Revenue had not conformed to the accelerated depreciation allowed through federal bonus depreciation and Section 179 for many years. They have long required an add back to Minnesota taxable income of 80% of accelerated bonus depreciation and Section 179 depreciation (except for allowing $25,000 in Section 179 depreciation with an investment limit of $200,000) that was allowed for federal tax purposes. However, the 80% depreciation add back is allowed to be taken as a reduction to Minnesota taxable income, in equal amounts, over the next 5 years.
Minnesota Comes Into Conformity—Almost
In May 2019, the Minnesota Legislature passed a tax bill that conforms many of Minnesota’s tax laws with several of the federal tax code changes enacted by the Tax Cuts and Jobs Act, including the elimination of the ability for taxpayers to use the like-kind exchange gain deferral on tangible property. However, Minnesota did not conform to the increased federal bonus depreciation and Section 179 depreciation limits, which still requires an add back to Minnesota taxable income of 80% of the federal accelerated depreciation allowable deduction. Review our recent insight on Minnesota Tax Conformity by clicking here.
The conformity to the like-kind exchange elimination, but nonconformity to accelerated bonus and Section 179 depreciation, can result in a negative tax impact to Minnesota taxpayers in a year in which an ag producer trades in a used equipment unit for a new equipment unit. Depending on the cost of the new unit and the amount of time that has passed since the original unit was purchased, the resulting Minnesota tax liability can be substantial. It is important to point out that the nonconformity to accelerated depreciation by Minnesota does not typically result in any additional Minnesota income over the long term, because the full depreciation amount is ultimately allowed, just over a longer time line. But Minnesota taxable income will bed in the current year compared to federal income. Then, in future years, Minnesota income will be lower than federal income due to additional deductions allowed related to the equipment purchase.
The following examples illustrate the impact to Minnesota taxpayers:
Federal Impact: Regular depreciation methods were used on the equipment from the 2016 date of purchase through the date of trade-in during 2019. Due to the elimination of like-kind exchange provision by the Tax Cuts and Jobs Act, the realized gain of $54,017 on the trade-in of the old equipment ($250,000 trade allowance less $195,983 tax basis), results in a $54,017 federal income tax gain. However, the $425,000 new equipment purchase is eligible for 100% bonus depreciation, and if so elected to be used by the customer, will result in a $425,000 tax deduction. Thus, with election of bonus depreciation, the net impact of the 2019 trade-in transaction is a federal tax deduction of $370,983.
Minnesota Impact: The use of regular depreciation methods on the original purchase in 2016 through the trade-in date in 2019 did not create any depreciation add back for Minnesota purposes as is required when accelerated depreciation methods are used. Therefore, the benefit from the purchase of equipment in 2016 is not different for federal or Minnesota purposes, until the trade-in occurred. The net impact of the trade-in transaction in 2019 for Minnesota purposes is $55,481 of Minnesota taxable loss, composed of $54,017 of trade-in gain, created by the elimination of the like-kind gain deferral, less $85,000 of allowable depreciation on the 2019 new equipment purchase ($425,000 new equipment purchased X 20%), less $24,498 of regular depreciation on the original 2016 purchased equipment prior to trade-in. The balance of the allowable depreciation on the 2019 equipment purchase is taken for Minnesota purposes equally over the next 5 taxable years beginning with 2020.
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