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Do you have property
in the "path of progress?" Is selling your farmland for
development just a matter of time? Want to consider a 1031 Tax
Deferred Exchange?
Don’t wait until you
sell your current property to begin looking at a 1031
exchange. Exchanges are complex and time sensitive. Obtaining
expert advice from an attorney and tax advisor who are
well-versed in tax deferred exchanges should be one of your
first steps in the planning process.
The 1031 term comes
from the U.S. Internal Revenue Code Section 1031 that lays out
the statutory rules for the tax-deferred exchange of property.
Basically, a 1031 exchange is a means of deferring payment of
capital gains tax, which can run 20 percent or higher, when a
landowner disposes of property that has either been held as an
investment or used in the property owner’s business or trade.
A farm is a business and is treated as such when it is sold.
The key is that the property owner must replace it with a
property of like kind (commercial or agricultural) that will
be used either for investment purposes or as a business. Many
farmland owners use this as an opportunity to trade higher
priced path-of-progress acres for additional farmland acres in
a location further from growth areas.
A landowner should
begin planning well into the future if there is a likelihood
that the farm will be sold, particularly for development
purposes. Start planning early, even before a buyer approaches
you. If there is going to be a development involved, you
should figure it will take up to a year just for zoning,
utilities plans and other administrative paperwork to get
settled.
Points to consider
There are many details to consider in
completing a tax-deferred exchange. They include:
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An exchange is not
always the best option. Your legal and tax advisors should
help you to decide if a tax-deferred exchange is right for
your tax situation and investment strategy.
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The tax on realized
gain is deferred under Code Section 1031 only if the
transaction is structured as a transfer or exchange, rather
than a sale of the property.
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The IRS has adopted
"safe-harbor rules" which, if followed, will permit the
transaction to qualify for non-recognition of gain.
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Some exchanges may
be only partially tax deferred because the landowner
("Exchanger") receives money or "unlike" property in
addition to the like-kind property.
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Exchanges must be
completed within strict time limits. The Exchanger has 45
days from the date the relinquished property is transferred
to identify potential replacement property. The purchase of
the replacement property must be completed by the earlier
of: 1) 180 days after the relinquished property is
transferred; or (2) the due date (including extensions) for
the Exchanger’s tax return for the taxable year in which the
transfer of the relinquished property occurs.
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A tax deferred
exchange usually includes the use of an independent, third
party "Qualified Intermediary" – an entity that facilitates
the exchange.
There are many more
issues to consider. You should establish the structure and
details of the transaction carefully with your attorney and
tax advisor. Don’t be afraid to ask questions.
The "shopping" process
How does one find a
suitable replacement property? There are many options.
You can start checking
out websites and real estate ads to see what is available. You
might also watch auctions, but such transactions present some
challenges in terms of timing requirements. You also can sign
with a buyer’s broker and have a professional do the legwork
for you. On this one, make sure your broker is knowledgeable
on the type of property you are seeking, and be sure to
specify exactly what it is you are looking for, including
particular geographic areas and, of course, the price range.
When it comes to
farmland, a professional agland broker such as CAPS can tell
you what is available and where, and for what price. You also
can do additional looking on your own by checking out ‘Green
Sheets’ that list land sales, subscribing to land sales
bulletins that are available or by checking with your local
1st Farm Credit Services offices, as they tend to be very much
in the loop on land sales and prices.
Other things to consider
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Location. Location. Location.
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Soils. Could be very important,
depending on the type of farming operation involved.
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Tiled fields and/or proper drainage.
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Crop bases in regard to federal crop
programs.
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Real estate taxes.
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Lease situations.
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Wetlands or woodlands, and if they
are covered by government programs or other covenants.
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Environmental issues.
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Status of buildings.
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Fertility. Recent crop yields and the results of recent
soil tests.
Types of exchanges
There are a number of
variations in the form a 1031 tax deferred exchange can take.
They include:
A Simultaneous Exchange – in which the relinquished
property is sold and the replacement property acquired at
the same time. A Qualified Intermediary may or may not be
involved.
A Delayed Exchange (also known as a "Starker Exchange")
– in which a Qualified Intermediary is utilized to close the
sale and receive the proceeds of the relinquished property
until the Exchanger identifies and acquires the replacement
property.
A Reverse Exchange – in which the replacement property
is purchased prior to closing the sale of the relinquished
property. The Exchanger uses a Qualified Intermediary to
purchase the replacement property while the relinquished
property is marketed and closed.
The most important thing is to get your attorney and tax
advisor involved early in the planning process. The IRS rules
are complicated. Exchanges can offer excellent tax advantages;
however, they must be structured carefully in accordance with
all the applicable laws and regulations to realize the tax
benefit.
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Keith
Scoggins
Doug W. Deininger, AFM, CCA