Selling a Farm or
Selling a farm or a ranch, like selling any business, often involves
many different types of assets. The transaction or transfer may
include not only real estate land and buildings, but equipment,
livestock, water rights, mineral rights, air rights, crops,
inventory, and animals.
interested in selling a farm or ranch considering a like kind
exchange under Internal Revenue Code §1031 or multiple other tax
deferral, deduction or reduction alternatives should focus on the
particular property being sold, purchased, transferred or bequeathed
in order to maximize various tax tools including the amount of
capital gain and depreciation recapture that they will be able to
defer or deduct.
The first step for a seller thinking of exchanging his or her farm
is to itemize the various assets and determine which of those assets
are exchangeable under §1031 (same for §1033-§721; for this writing
1031 will describe all three IRC sections).
Goodwill and inventory are not exchangeable under §1031.
Additionally, the Tax Cuts and Jobs Act of 2017 eliminated the
ability to exchange personal property assets under §1031 (equipment,
livestock, etc.); however, the legislation did create a tool
allowing for the immediate expensing of certain types of newly
acquired business assets. Farm sellers should talk with their tax
advisors about the immediate expensing rules to see if any new
equipment acquisitions can benefit from this tool.
The largest asset of many farm and ranch sales is the real estate.
Real estate used in a trade or business or held for investment can
be exchanged for like kind real estate under Internal Revenue Code
Exchanging Real Property
Real Estate and Buildings: The
real estate assets of a farm include the land and any improvements
attached to the land such as a house or a barn. If the house on the
farm is occupied by a tenant, worker, or caretaker on the property,
it is considered investment property or property used in a trade or
business and is exchangeable under §1031. On the other hand, if the
owner lives in the house, the house is considered the owner’s
personal residence and would not be exchangeable.
There are various tax strategies involving selling property that is
both a personal residence and investment property. If property is
held partially for personal use and partially for investment, such
as a working ranch with a house on it in which the owner lives, a
portion of the gain from the sale of the personal residence is
exempt from tax under IRC §121 and the remaining tax can be deferred
under §1031. Revenue Procedure 2005-14 clarifies how Sections 121
and 1031 can be used at the same time in connection with the
disposition of the same property.
crops are considered inventory and are not exchangeable under §1031.
It is possible to exchange non-harvested crops when they are sold
with the land, at the same time and to the same person, provided
that the land was held by the owner for investment purposes for more
than one year. In addition, in order to trade the non-harvested
crops for real estate, the non-harvested crops must be considered to
be real estate under state law.
Water Rights / Mineral
Rights / Air Rights: The IRS has held that
perpetual water rights are like kind to a fee interest in real
estate. The rights must not be limited in amount or duration.
Additionally, shares in a mutual ditch, reservoir, or irrigation
company can be exchanged if at the time of the exchange certain
requirements are met including (1) the company is an organization
described in I.R.C. § 501(c)(12)(A), and (2) the shares in such
company have been recognized as constituting an interest in real
property. Certain types of mineral rights that are considered real
estate may also be exchanged. Owners need to examine the nature and
duration of the rights granted and whether they are considered to be
real estate for tax purposes. Air rights have become more prominent
with wind power tower structures placement.
IRC §1031 allows for the deferral of capital gain tax if
property held for business or investment is exchanged solely for
property of "like-kind". Contrary to what many people believe,
"like-kind" does not mean that an investor must exchange a farm for
a farm. In the context of real estate, like-kind exchanges are valid
between and among any interest in real estate including bare land,
commercial property, industrial buildings, retail stores,
apartments, duplexes - even leasehold interests exceeding 30 years
and some water and mineral interests as described above. So farm or
ranch owners can 1031 exchange into another farm, a duplex, a
commercial building, or any other interest in real estate.
Any replacement property purchased
within the 45-day identification period is deemed properly
identified, but if an investor cannot close on his replacement
property within the 45-day identification period, formal
identification is necessary. Identification must be in writing and
can only be sent to either the exchange company, the seller, or to
any other person involved in the exchange who is not a disqualified
party. The taxpayer’s real estate agent and attorneys are
disqualified parties. The IRS has imposed limits on the number of
properties that may be identified. These include limiting the
properties to no more than three potential replacement properties
(the “three property rule”), or if more than three are identified,
the total fair market value of all of the property identified cannot
be greater than twice the total fair market value of the property
sold (the “200% rule”).
If a taxpayer cannot meet the three property rule or the 200% rule,
there is a third rule called the “95% rule”. Under this rule, you
can identify as many properties as necessary without regard to fair
market value, but you must purchase 95% of the value of all of the
properties identified. This generally means the taxpayer has to
purchase all of the identified property which can be very difficult.
Identification should include a complete address or legal
description, and if acquiring less than a 100% interest, an
indication of the tenancy in common interest share being acquired.
The sale of a farm or ranch typically
involves more than just real property. Understanding the different
tax tools can help investors maximize their tax saving and the
amount available for re-investment.
To view multiple
other alternatives for farm, ranch and associated property tax
deferral or deduction go