Minnesota Nonconformity: Impact to Ag Producers

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:

1. The expansion of bonus depreciation to 100% expensing on both new and used tangible property.
2. The expansion of the Section 179 depreciation limit to $1,000,000 with a $2,500,000 investment phase-down threshold.

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.

Minnesota Nonconformity
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.

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.

Real-Life Examples
The following examples illustrate the impact to Minnesota taxpayers:

1. Customer purchased equipment in 2018 for $3.5 million and took 100% bonus depreciation in 2018 on the equipment purchased. In 2019, the customer trades in this equipment on new equipment valued at $3.5 million, receiving a trade value on the old equipment of $3 million and paying a $500,000 trade-in difference.
   
   
   1. Federal Impact: The original purchase in 2018 creates a federal deduction of $3.5 million. Then, due to the elimination of like-kind exchange provision in the Tax Cuts and Jobs Act, the realized gain of $3 million on the trade-in of the old equipment ($3 million trade allowance less $0 tax basis), results in a $3 million federal income tax gain. However, the $3.5 million new equipment purchase in 2019 is eligible for 100% bonus depreciation, resulting in a $3.5 million tax deduction. The net impact of the trade-in transaction is a $500,000 federal tax deduction in 2019.
      
      
   2. Minnesota Impact: Using the same facts and the Federal Impact described above as a starting point, the original $3.5 million 2018 purchase, which created a $3.5 million deduction in 2018 for federal purposes, only creates a $700,000 deduction for Minnesota in 2018. Minnesota requires that 80% of the federal accelerated deprecation deduction be added back when commuting Minnesota income. As a result, $2.8 million (80% of $3.5 million) is added to Minnesota taxable income in 2018 due to bonus depreciation nonconformity and is not factored into the Minnesota basis in the assets traded-in in 2019. Rather, that $2.8 million is allowed to be deducted equally over 5 years, regardless of whether the taxpayer still has the original equipment or not, resulting in a deduction in 2019 of $560,000. The net impact of the trade-in transaction in 2019 for Minnesota purposes is $1,740,000 of Minnesota taxable income, composed of $3.0 million of trade-in gain, created by the elimination of the like-kind gain deferral, less the $560,000 depreciation deduction from the 2018 purchase and $700,000 allowable depreciation deduction on the 2019 equipment purchase.
   
   
   3. Summary of taxable income impact of 2018 and 2019 purchase and trade from 2018-2024, assuming no additional trade-in in future years:

   	Federal	MN
   2018	(3,500,000)	(700,000)
   2019	(500,000)	1,740,000
   2020	-	(1,120,000)
   2021	-	(1,120,000)
   2022	-	1,120,000
   2023	-	(1,120,000)
   2024	-	(560,000)
   	(4,000,000)	(4,000,000)



2. Customer purchased equipment in 2015 for $300,000 and took $300,000 of Section 179 depreciation in 2015 on this asset. In 2019, the customer trades in this equipment on new equipment valued at $350,000, receiving a trade value on the old equipment of $100,000 and paying $250,000 trade-in difference. Minnesota treats Section 179 depreciation a little different than bonus depreciation, but in most cases, as in this example, because the amount of the original 2015 purchase and the new 2019 purchase exceed the allowable levels for any Section 179 benefit, the result will be the same as if dealing with bonus depreciation and will follow the same transaction flow as described in Example 1.
   
   1. Summary of taxable income impact of 2015 and 2019 purchase and trade from 2015-2024, assuming no additional trade-in future years.
   
   

   	Federal	MN
   2015	(300,000)	60,000
   2016		(48,000)
   2017		(48,000)
   2018		(48,000)
   2019	(250,000)	18,000
   2020		(104,000)
   2021		(56,000)
   2022		(56,000)
   2023		(56,000)
   2024		(56,000)
   	(550,000)	(550,000)



3. Customer purchased equipment in 2016 for $400,000 and did not take accelerated depreciation on the unit. Normal depreciation results in a net tax basis of $195,983 at the time of trade-in in 2019. In 2019, when the customer trades in this equipment on new equipment valued at $425,000, the customer received a trade value on the old equipment of $250,000 and paid a $175,000 trade-in difference.
   
   

   1. 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.

   2. 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.

   3. Summary of taxable income impact of 2016 and 2019 purchase and trade from 2016-2024, assuming no additional trade-in in future years.