There are many important financial issues to be aware of when selling a farm or ranch. Planning for a sale with a team of advisers well in advance of a sale is critical for identifying these issues and for implementing strategies to effectively deal with them. One of the biggest issues is the income tax that can result from a sale.
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% of the sale price depending on the cost basis of your property and how your property is owned. Prior to listing your property, it is wise to have a CPA perform a tax projection on the sale. Having an estimate of the tax bill you would face is valuable information when considering tax-saving strategies.
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 can save tax. Money that would have gone to paying tax can then be invested to help generate income for you and your family.
A 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 gain 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.
There are specific rules and strict time frames pertaining to a 1031 exchange. Replacement property must be identified within 45 days after closing on the sale of your farm and ranch and replacement property must be closed within 180 days after the sale. It is best to work with an Qualified 1031 Exchange Intermediary to facilitate a 1031 exchange.
A charitable remainder trust (CRT), sometimes referred to as a capital gains avoidance trust, can be another powerful tool to defer or entirely avoid capital gain 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.
A CRT provides many potential benefits for an agricultural family:
- Saves tax on the sale of appreciated land and on the sale of livestock, machinery and equipment.
- The full sales proceeds can be invested which allows a family to generate more retirement income as opposed to investing after tax proceeds from a straight sale.
- Provides a vehicle to diversify assets for retirement income.
- May reduce or avoid estate taxes.
- Supports one’s favorite church and/or charities.
- Provides a lasting legacy for the donors.
Using a combination of a 1031 exchange, charitable remainder trust and a direct sale for cash can often be an optimal strategy for reducing income and estate taxes and providing diversification of investment assets.
A home is typically involved with the sale of a farm or ranch. The IRC Section 121 Personal Residence Exclusion 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. To help maximize the amount of tax-free cash you may receive from the sale of a farm or ranch containing a personal residence, it may be possible to include additional acreage with the home.
If you are selling or considering selling a farm/ranch, now is the time to start the education and planning process. There can be complex financial issues involved and if not addressed correctly and prior to a sale, the tax benefits and subsequent investment opportunities may be missed. Working with a team of advisors who collaborate together on your behalf will ensure all areas are properly addressed and will help you achieve your financial goals in the most effective manner possible.