With the recent increase in land prices for farmers and ranchers, a 1031 exchange can be a tremendous tax savings opportunity. The current increase in the capital gains rates to 20% plus the healthcare tax of 3.8% will warrant prudent tax planning by today’s family farm.
A 1031 exchange allows for real property held for use in investment, trade or business to be exchanged for other like kind property and can result in a complete deferral of all taxes due, including state and local taxes. This means that the disposition of farmland and subsequent purchase of new investment real estate can be virtually tax free. 1031 exchanges are sometimes called Starker Exchanges based on the court case that helped define the regulations.
Recently, we were involved in an exchange of farmland in Southern Michigan. Approximately 100 acres were sold at a fair market value of $11,000 per acre and exchanged into a new parcel that was more advantageous for farming in regards to proximity and ability to grow certain crops. All sales proceeds were invested into the new farmland. Not only was the tax deferred, but more profitable crops could be grown, and it was closer to the main farm.
One of the benefits of 1031 is that like kind real estate can mean almost any type of investment real estate. For example, farmland can be sold and other investment real estate can be purchased. Other examples of like kind real estate include rental houses, duplexes, condos, TIC interests, ranch land or commercial property.
Another recent example involved a large chicken farm in southern Iowa. The farmers were able to secure a buyer and the purchase price was allocated between the land value and the business. The business portion is taxable immediately, while the land was sold using a 1031. The land proceeds were reinvested into tillable farm land. The older couple now owns solid rental property that they will rent to local farms. No tax is due on the land sale, assuming that land of greater value is purchased.
There are other opportunities for farmers in deferring the taxes on their land sales or land rights. Some of the choices include:
- If there is a homestead on the property the house can be separated to take advantage of the Section 121 home sale rules to eliminate $250,000 per person or $500,000 per couple.
- There are states that consider water rights real property; these rights can be exchanged for income producing real property.
- Mitigation credits can be exchanged for other mitigation credits, which can make certain land more valuable to developers.
- Certain land has mineral rights that can be exchanged because they are a separate deed on the property.
- Unused land with timber or forest can be exchanged for other real estate.
- Easements can also be exchanged for other easements to grant rights to certain properties.
The final 1031 example involves ranch land in Colorado. An older couple was able to sell their ranch land that had an appreciated price from the original purchase. They had over $10,000,000 in gain. The proceeds were exchanged for new investment property in Florida. The tax on the gain would have been approximately $2,843,000.00. The new property was a large commercial rental property that included all NNN leases and had great cash flow since there was no debt. The couple was able to keep over $2.8M in their pockets and invest it in appreciating real estate. This is the power of a 1031 exchange.
Please note there are several rules that need to be followed in a 1031 exchange. Please request our 1031 Exchange Guide for more information.
Because of today’s economy, many farmers have had their wealth increase quite a bit over the last ten years. Never has tax planning been more important with the current set of tax laws. If you have questions about 1031 exchange, feel free to contact Dave Owens at 239-333-1031 for a free consultation.
Dave Owens, CPA, CES is the President of Midland IRA, in business since 1997 with offices in Chicago, IL and Fort Myers, Florida.