When selling farms and ranches, owners may use 1031 exchanges to adjust their land holdings by replacing less productive farmland with higher yielding cropland. 1031 exchanges for land, farms or ranches can also be sold to transition into less labor intensive holdings, including cash generating properties like triple net leases with CVS Pharmacy and Walgreens or oil and gas royalties. Often vacation properties are acquired for investment use that is limited to fourteen overnights per year of personal use, then converted into primary residence after two years. Investment property can always be converted after two years to personal use, such as a primary residence or second home.
When selling farmland or ranches, capital gains and recaptured depreciation taxes can be deferred when the investment property or acreage is exchanged for any type of real property held for productive use in a business or for investment. There are a number of 1031 exchange rules to be followed, including:
- Engaging a Qualified intermediary to facilitate the 1031 exchange
- Same taxpayer requirement – the taxpayer who sells is the taxpayer who buys
- To defer the 100 percent of the capital gains tax, property of equal or greater value is acquired
- Replacement property must be identified by the 45th calendar day and acquired by the 180th calendar day post initial closing
- If selling to a related party, the property must be held for two years; otherwise, the tax deferred is due
- If buying from a related party, the related party must also be initiating a 1031 exchange and not cashing out
Selling Farmland or a Ranch Utilizing IRC Section 121 and IRC Section 1031
When selling farmland or a ranch that has both a primary residence and land, it is important to consider the tax consequences of Internal Revenue Code Section 121 and Section 1031. Vacant land can be sold along with a primary residence, utilizing the $250,000 ($500,000 married filing jointly) exclusion given the property was owned and used by the taxpayer as the taxpayer’s primary residence for time totaling two years or more. The capital gain exclusion is available once every two years.
Recreational vs. Investment Surrounding Land
Given the primary home is surrounded by substantial adjacent land held for investment and not for residential purposes, a 1031 exchange should be considered to defer the gain on the land. Consequently, the home can be excluded from gain under Section 121 and investment or land held in the productive use of a farm or ranch excluded from gain under Section 1031.
Separate Dwelling Unit
Revenue Procedure 2005-14 addresses mixed use property where a primary residence exists as a separate or same dwelling unit with non-residence property such as a farmhouse, apartment unit, hotel, motel, inn or bed and breakfast. To determine the amount of gain accounted for from the primary home and non-residential buildings or building portions, the taxpayer may allocate basis and realized gain by proportioning the amount of grass typically cut around the primary home and the remaining land and out buildings held for investment.The Section 121 exclusion is applied first to the primary residence and Section 1031 applied to the investment or non-residence portion.
The outcome of a farm or ranch closing are preferably separate settlement statements reflecting the primary residence separate from the investment or real property. Affixed irrigation equipment, including center pivots, pumps, filters and supply pipes are considered real property improvements, while portable water wheels not affixed to the ground are considered personal property and are therefore ineligible. The 1031 exchange agreements should not reflect the primary residence. The taxpayer may receive cash from the sale of their primary residence while the investment proceeds are wired to the qualified intermediary for the 1031 exchange.
Deferred Sales Trust ™, an alternative to a 1031 exchange
If the decision after visiting with the CPA is not to acquire replacement property, yet defer the capital gain taxes, then a Deferred Sales Trust or DST may be the right strategy. A DST does not require the purchase of replacement property; rather the proceeds are invested per your direction in securities and annuities in a trust created for your benefit. You determine when and how much of the principal you want to receive annually. Earnings can be received, leaving the principal alone. Capital gain taxes are paid in the year principal is received.
A complimentary illustration can be created to help determine whether a DST makes sense. A follow up phone call is scheduled to discuss the illustration outcome, questions and next step. To learn more about a DST, download this PDF.
If you are considering a 1031 exchange of farm land or a ranch, Atlas 1031 provides the accommodation services compliant with Internal Revenue Code Section 1031. Click below to begin a consultation or call our office at 1 800 227 1031 to discuss your farm land or ranch 1031 exchange.
