If you are considering selling a farm or ranch, there are important tax and financial planning issues of which you need to be aware. Engaging in planning prior to a sale is critical for identifying these issues and for implementing strategies to effectively address them.
Taxation of farm and ranch assets
Various tax rates and tax treatment apply to the different types of assets involved with the sale of a farm or ranch. How you allocate the sales price to the assets of your farm/ranch will determine the tax you may ultimately pay. It is imperative that you seek direction from your tax advisors when purchase price allocation is being negotiated.
Tax saving tools for selling appreciated property
Selling highly appreciated (or depreciated) property can result in a large tax bill. Taxes due on the sale may range from 20% to over 50% on the gain, depending on the cost basis of your property and how your property is owned.
Two financial tools are commonly used to defer or avoid tax on the sale of highly appreciated (or depreciated) property: IRC Section 1031 Exchange and IRC Section 664 Charitable Remainder Trust (CRT). Using one or a combination of these tools with a sale may save tax. Money that would have gone to paying tax can then be invested to help generate income for you and your family.
IRC Section 1031 Tax-Deferred Exchange
The IRC Section 1031 Exchange can be a powerful tax saving and wealth building tool that allows a taxpayer to sell property and purchase other property without currently recognizing capital gains tax on the sale. To quote the tax code: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment purposes if such property is exchanged solely for property of a like-kind which is to be held for either productive use in trade or business. The definition of “like kind” is very broad. Land, for example, can be exchanged for other types of real estate such as office buildings, apartment complexes etc.
IRC Section 664 Charitable Remainder Trust
A charitable remainder trust (CRT), sometimes referred to as a capital gains avoidance trust, can be another powerful tool to defer or avoid capital gains tax on the sale of appreciated real estate. In addition to avoiding tax on the sale of real estate, a CRT can also be used to avoid tax on the sale of other assets such as livestock, machinery and equipment. Combining A CRT and a 1031 exchange can be a powerful combination for preserving wealth and accomplishing other estate planning and charitable giving goals.
IRC Section 121 Principal Residence Exclusion
IRC Section 121 allows an individual to exclude up to $250,000 of taxable gain from the sale of a principal residence and a married couple filing a joint return to exclude up to $500,000 of gain. It may be possible to allocate additional acreage with a personal residence to maximize this tax saving opportunity.
Real estate comprised of multiple separately deeded parcels
Farms and ranches are often composed of multiple, separately deeded parcels with varying cost basis figures. This typically happens as additional parcels of property are purchased over time to expand the capacity of the farm or ranch. If you are considering a 1031 exchange for part of the sale, a potentially effective tax-saving strategy is to obtain separate buy-sell agreements on each parcel so you can exchange the low-basis parcels and take cash out of the high basis parcels.
Owning farm/ranch real estate inside an entity
How you own your farm/ranch impacts the tax treatment and planning options available to you. While most people own real estate today in the name of an LLC, partnership or S Corporation, there are still those who own property in a C Corporation. Selling appreciated property in a C corporation can be a tax nightmare with tax rates potentially exceeding 50%.
Exchanging property owned by multiple partners/shareholders
Owning appreciated real estate in an entity can create problems when it comes time to sell the property. Challenges arise if there are multiple partners/shareholders with different goals upon sale. For example, if a property is in a partnership, one partner can’t do a 1031 exchange for their share. The IRC 1031 exchange provisions require that the entity selling the relinquished property must be the same entity taking title to the replacement property. There are planning strategies to effectively deal with this situation.
You and your family have worked hard to create the equity in your farm or ranch. When it comes time to sell, you need to work smart to preserve that equity and to make your money work as hard for you as you’ve worked for it.