A 1031 Exchange is a tax-deferred swap program in which farmers and others in the agriculture industry can participate. Farmland, vacant land, and certain agriculture assets are considered real estate assets under the Internal Revenue Code. As much, farmers and others are able to utilize Internal Revenue Code (IRC) Section 1031 in order to defer tax upon the disposition of farmland and acquisition of a “like-kind” piece of property.
Section 1031 exchanges, which originally began in the 1920’s, have seen numerous tweaks and changes over the years to get us to the rules that are in place today. IRC Section 1031 allows a taxpayer to defer (not avoid) capital gains taxes realized upon the disposition of a property if the taxpayer replaces the property with a “like-kind” asset of equal or higher value. In order for the taxpayer to defer taxes, they must identify the new property within forty-five days of the disposition closing date and close on the new “like-kind” property within 180 days of the disposition closing date. In order for the taxpayer to fully defer capital gains tax, they need to purchase an asset of equal or higher value. If they purchase an asset of lesser value, the taxpayer must pay tax currently on the difference in value. Certain rules and guidance allows for taxpayers to include any improvement costs on their new asset in the value calculation for deferral treatment. While there has been extensive guidance and content on 1031 Exchanges in the context of residential, retail, office, and industrial properties, there is a lack of content on how 1031 exchanges apply to the agriculture industry. I have identified five items that all farmers and agriculture business owners should know, as follows:
#1 – You’re allowed to do a 1031 Exchange on your Farmland
Should you wish to sell your existing farm land and buy like kind property, this exchange should qualify for tax deferred treatment, meaning you don’t have to pay the tax currently. When exchanging land for another real estate property only, the rules are fairly straight forward. Real property farmland is still allowed to be included in a 1031 Like Kind Exchange.
#2 – The Tax Cuts & Jobs Act of 2017 changed the rules for Farmers
The Tax Cuts & Jobs Act of 2017 (Tax Reform) brought huge changes to the tax structure in the United States and the agriculture industry was not exempt. Within the context of 1031 exchanges, the TCJA eliminated personal property from 1031 exchange eligibility. This means that agricultural personal property such as equipment, machinery, livestock, etc. cannot be included in the exchange. The taxpayer would owe tax currently on the sale on personal property. However, as previously mentioned, the land itself is still eligible for 1031 Like Kind exchange tax deferral treatment.
#3 – Taxpayers can Improve Farm Land & Qualify
In order for the exchange to be fully tax deferred, the general rule is that a taxpayer must buy a property for equal or higher value than the property disposed of. However, taxpayers are allowed to improve the new property purchased and include the improvements in the total value of the new property, as long as these improvements are completed within 180 days of the closing date of the disposed property. Certain improvements to raw land, such as irrigation, planting crops, infrastructure improvements, etc. might qualify as improvement costs in a 1031 Exchange transaction. The same improvements might also qualify as "Substantially Improving" a qualifying investment through an Opportunity Zone Fund when additional Opportunity Zone guidance is issued in the Fall/Winter of 2019.
#4 – Certain Conservation Easements Can Qualify for 1031 Treatment
The IRS has concluded in a number of different Private Letter Rulings that Conservation Easement transactions can qualify for 1031 Exchange Treatment if the taxpayer rolls funds received into additional like-kind property. Private Letter Ruling 200649028 clarified the rules when a taxpayer receives tax credits rather than cash as part of a conservation easement. If the rules in PLR 200649028 are properly followed, receiving credits rather than cash can still qualify for 1031 Exchange tax treatment. Consult your tax advisor if considering a 1031 Exchange as part of a Conservation Easement.
#5 – Issues Arise when Land also has Depreciable Property
Generally, when exchanging real estate in a 1031 exchange that includes a depreciable property (remember, land is never depreciated) such as a single-purpose agricultural building, warehouse, irrigation system, or barn, the taxpayer is required to recognize the previous depreciation on disposition of the property in a 1031 Exchange to the extent the replacement property does not have depreciated assets. Assets subject to this “depreciation recapture” concept are referred to as “Section 1245 Property.” Consideration should be given to the type of replacement property purchased when disposing of property subject to Section 1245 in order to maximize the full tax benefit of a 1031 Exchange.
While the tax benefits of a 1031 Exchange are great, the downside of the exchange is that it takes a “Qualified Intermediary” to handle the transaction. Given the complexity of the rules and the importance of meeting key dates in the transaction, using a seasoned expert in this area will assist in ensuring your transaction meets the proper qualifications. The qualified intermediary sells the relinquished property to the buyer on your behalf and purchases the new, like-kind replacement asset on your behalf. The tax benefits of a 1031 Exchange are substantial and can be used as part of a Succession Plan. As mentioned, the Tax Cuts & Jobs Act of 2017 restricted qualifying property and a consultation with your tax advisor or a qualified intermediary is necessary if considering an IRC Section 1031 Exchange.
This article should not be construed as, and should not be relied upon as legal or tax advice.
Tyler Davis works for SVN: Saunders Ralston Dantzler real estate and also owns his own CPA Firm, Tyler Davis CPA where he provides tax preparation, consulting, and provision services. SVN: Saunders Ralston Dantzler is leading agricultural land brokerage based in Lakeland, FL. Tyler can be contacted at firstname.lastname@example.org.