If you are considering selling your 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 with the right team of professionals is critical for identifying these issues and for implementing strategies to effectively address them.
Taxation of Farm and Ranch Assets
Taxes on the sale of a farm or ranch that has appreciated in value may range from 15% to over 50% depending on the taxable gain of the land, how the property is owned and the type of assets involved in the sale. A farm or ranch sale will typically involve the realization of gain on a “mixed bag” of assets. Some gain will need to be recognized as capital gain or ordinary income in the year of sale, while some realized gain might not need to be recognized due to the use of IRC Sections 121, 664 or 1031.
This “mixed bag” of assets often includes a personal residence, fixtures (outbuildings, barns, fences, wells, etc.), personal property (equipment, sprinkling systems, livestock, etc.), and land. Internal Revenue Code Section 1060 requires that “the consideration received for such assets shall be allocated among such assets.”
Allocation of Sale Price
How you allocate the sale price to the assets of your farm or ranch will determine the tax you may ultimately pay. Therefore, it is imperative that you seek direction from your tax advisors when purchase price allocation is being negotiated.
Conflict can arise when negotiating the allocation of sale prices to the different types of assets involved in a sale. Sellers typically want to allocate more to assets they will pay tax on at capital gain rates and buyers want to allocate more of the sale price to depreciable assets.
Generally, both the purchaser and the seller must file IRS Form 8594 when there is a transfer of a group of assets that make up a trade or business, including a farm or ranch. This form lists the assets involved in a sale and the allocation of price to each of those assets. Form 8594 is to be included with the income tax returns of the buyer and seller for the year of the sale.
Tax Saving Tools for Selling Appreciated (or Depreciated) Property
Selling highly appreciated (or depreciated) property can incur hefty tax consequences. Fortunately, there are strategies one can use to reduce or completely bypass taxes on a sale.
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 reduce taxes incurred on a sale. By using these tools, money that would have gone to paying tax can be invested to generate income for you and your family.
IRC Section 1031 Tax-Deferred Exchange
The IRC Section 1031 Exchange can be a valuable tax-saving and wealth-building tool for an agricultural family. It 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.
Many farm and ranch owners hold the belief that land must be exchanged for other land. This is not true. Land can be exchanged for other types of real estate such as office buildings, apartment complexes, rental houses etc. The ability to exchange land into these other types of real estate may allow an agricultural family to significantly increase their cash flow. Our clients often increase the net returns on the equity in their land from around 2% annually to 7% or greater, annually.
There are several rules and strict time frames that need to be adhered to if you are going to complete a successful tax-deferred exchange. Replacement property must be identified within 45 days of closing on the sale of your land and must be closed within 180 days.
IRC Section 664 Charitable Remainder Trust
A Charitable Remainder Trust (CRT), sometimes referred to as a capital gains avoidance trust, can be another valuable tool to bypass capital gains tax on the sale of farm and ranch property. In addition to avoiding tax on the sale of real estate, a CRT can also be used to bypass tax on the sale of other assets such as livestock, crops, machinery and equipment.
Using a CRT to sell property can:
- Bypass taxes on the sale
- Decrease income taxes with charitable deductions
- Increase annual income for retirement
- Reduce or eliminate estate tax
- Increase wealth passed to heirs by combining with other strategies
- Create legacy gifts to favorites charities
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 principal residence to maximize this tax saving opportunity.
Real Estate Comprised of Multiple Separately Deeded Parcels
Farms and ranches are often made up of multiple, separately deeded parcels with different cost basis amounts. If you are considering a 1031 exchange or charitable remainder trust for part of the sale, a potentially effective tax-saving strategy is to exchange or sell through a CRT the low-basis parcels and take cash out of the high basis parcels. Advance planning is required for using this strategy.
Owning Ranch Real Estate Inside an Entity
How you own your farm or ranch impacts the tax treatment of your property and planning options available to you. While most people own real estate today in the name of an LLC, partnership or S Corporation, some still own property in a C Corporation. Selling appreciated property in a C corporation can incur taxes exceeding 50%.
Exchanging Property Owned by Multiple Partners or 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 cannot 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.
Investing Sale Proceeds
How you invest the proceeds from the sale of your ranch will determine the retirement lifestyle you enjoy and the amount of wealth you pass to your heirs. This is not a decision to make lightly. Whether you are investing cash or 1031 exchange proceeds, you should seek out professional advice. If you are investing cash proceeds, it is wise to work with an independent, fee-only registered investment advisor who uses low-cost funds and has a fiduciary obligation to working in your best interest. If you are looking for commercial income producing replacement properties, seek out the assistance of a commercial broker who has access to properties nationwide.
Selling a highly-appreciated ranch may require the expertise of several types of professionals. A team that collaborates on your behalf will ensure every area is properly addressed. Your team may include a:
- Farm/Ranch Broker
- Certified Public Accountant (CPA)
- 1031 Exchange Intermediary
- Tax and Estate Planning Attorney
- Wealth Management Consultant / Investment Advisor
- Planned Giving Advisor
- Commercial Real Estate Broker
- Real Estate Appraiser
You and your family have worked hard to create the equity in your 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.