Installment contracts ease tax burden

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If you are near retirement age and plan to sell your assets, you may be faced with an unexpected tax problem. Often times, the sale of property increases a producer’s income for that year and pushes him into a higher tax bracket and, therefore, makes him subject to higher capital gains taxes.

This predicament often occurs when farmers do not have any heirs interested in taking over the farming operation, or when producers sell a portion of their assets to generate cash for retirement. However, you can minimize the tax complications by using an installment contract when you sell real estate and home-grown breeding stock. An installment contract allows you to sell assets and receive payments over a period of time, while limiting your income-tax liability to just the proceeds received each year.

Let’s take a look at a typical example and see how the installment contract works. Say you purchased a farm 40 years ago and paid $1,200 per acre. Now, you decide to sell the farm to your neighbor for $2,000 per acre, resulting in a profit of $800 per acre or a gross profit percentage of 40 percent ($800 divided by $2,000). So, if you receive $500 per acre in principal during the initial year of the installment contract, you will need to pay taxes on $200 (40 percent of $500), plus any interest payments received.

Interest rate advantage
In addition, you may be able to receive more interest from an installment sale than you could by selling the property outright and investing the cash after paying taxes. Interest rates on long-term certificates-of-deposit are running at 6.5 percent, compared to 8 percent to 9 percent for the average installment contract.

This past September, the Internal Revenue Service set the minimum interest rate on installment contracts at 6.09 percent for unrelated parities if the contract called for annual payments and had a term of more than nine years. The minimum set for sales between related parties was 6 percent.

The Internal Revenue Service publishes the minimum rates monthly, so you will need to check with your attorney or accountant before finalizing any agreements. The installment contract tends to be a pretty safe investment because you get the property back if the buyer defaults.

Less income per year
If you are on Social Security, you may find some additional advantages of selling on contract rather than an outright sale. Although you don’t pay self employment or Social Security tax on the sale of a capital asset, your Social Security benefits could become taxable if you receive a large amount of income during a given year. An installment contract will generate less taxable income than if you sold the property outright. An installment contract may also expose less of your Social Security benefits to income tax.

For example, if you are married and your other non-Social Security income plus 50 percent of your Social Security benefits exceeds $32,000, you’ll pay income tax on a portion of your Social Security benefits. (For single seniors, the limit is $25,000.) You may be taxed on up to 85 percent of your Social Security benefits.

It is important to note that the tax treatment of installment agreements becomes more complex when you deal with depreciable machinery or cattle. You can still execute an installment agreement, but the tax benefits may not be as great as with real estate.

For a more complete explanation on installment contracts and other business agreements, talk to your accountant or attorney. You also may want to review a copy of “Farm Estate & Business Planning” by Neil Harl, agricultural economist at Iowa State University. To order, call Ag Executive at 309-772-2168. Cost is $26.95, plus $3.50 shipping and handling.

Darrell Dunteman, AAC, is an Accredited Agricultural Consultant and accountant with offices in Bushnell, Ill.



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