Retirement Tax Planning for Farmers

The decision to retire is often met with either enthusiasm or fear. Some farmers are counting down the days until retirement, and others are scared to retire because they aren’t sure what they will do without work. Many farmers who have worked so hard for decades have not developed any hobbies outside of farming. The decision to retire is often one of uncertainty. In evaluating this decision, farmers should analyze not just the physical reasons to retire, but also the financial implications of this decision.

The first question that farmers must answer is, "What do I want to do in retirement?" What type of lifestyle does the farmer want to live? Do they want to continue to live modestly and in a rural area, or are they ready to cash in on a lifetime of hard work, move to the beach, and go fishing every day? Having a solid answer to this question is a pre-requisite to evaluating the financial and tax issues that follow.

Another decision that has a significant financial planning impact is whether the farmer wants to retain ownership of the land. Farmers who currently lease their land have one fewer decision to make. However, if a farmer owns the property, they must decide whether to sell or lease the land. Leasing the land to someone else can provide an income stream in retirement. Selling the property but offering owner financing can provide a similar income stream. Selling the land can take time and have many tax implications and planning opportunities. Farmers who sell their land should consider a Section 1031 Exchange to defer the capital gains tax on the sale. This exchange would allow the farmer to reinvest the proceeds in an income-producing property close to the area where they wish to retire. Often times, these commercial income-producing properties can be completely hands-off by hiring a property management company. Farmers can defer capital gain tax until death through a 1031 Exchange, and their heirs will inherit the property with a tax basis equal to fair market value. This means the capital gain taxes on the sale of your farmland can be avoided.

Another financial implication of retirement is evaluating the tax impacts of your retirement savings accounts. Most retirement savings accounts are tax-deferred, meaning, the taxes are paid when the funds are withdrawn. These accounts include a 401(k), a standard IRA, and a Self-Employed Pension (SEP). Farmers who possess any of these accounts and are considering retirement should be aware that minimum distributions are required from these accounts once the account owner turns 70 ½ years old. Additionally, distributions cannot occur penalty-free until the account owner turns 59 ½ years old. Farmers should sit down with their financial advisor or CPA to plan out when these distributions should begin. Factors impacting this decision include the number of retirement years you expect to have, account balances, market factors, and your overall financial situation. Often times, farming retirees convert a large portion of their investments to an annuity fund, which provides a monthly income stream for a specified number of years. Annuities are attractive to farmers because many farmers are accustomed to living modestly and on a budget.

One of the driving factors for where people retire is state taxes. Some states, such as California, New York, New Jersey, Iowa, and Oregon impose extremely high tax rates for individuals. For many retirees, they cannot afford to pay state taxes on top of normal federal taxes. Therefore, these taxpayers look to retire in lower-tax states such as Florida, Tennessee, and Texas. Further, the Tax Cuts & Jobs Act of 2017 (LINK) (aka “Tax Reform) reduced the amount of state taxes that are deductible on your federal tax return. This provision makes lower tax or no tax states even more appealing. For farmers with smaller retirement savings, state taxes sometimes impact where they choose to retire.

As farmers begin planning for retirement, they should also consider their estate planning options. Farmers should decide whether they want to leave money or property for their descendants, friends, or non-profits. As discussed, heirs of an estate receive land and real estate with a basis equal to fair market value at the date of death of the landowner. Property owners of retirement age should consider the tax benefits for their heirs inheriting the property. Farmers who wish to leave cash or other liquid assets to charities can donate those amounts during retirement rather than at death to receive a tax deduction for these gifts. Farmers and other taxpayers can gift money to others without the recipient incurring a tax liability as long as the gift does not exceed $15,000 per person in 2020. This tax-free gift threshold allows for many different estate and retirement planning opportunities.

One final retirement consideration is the current state of the stock market and interest rates. The recent market volatility as a result of the Coronavirus disease (COVID-19) will probably encourage farmers and taxpayers considering retirement to keep working until the market improves. Most investors have lost a significant portion of their retirement accounts because of the recent decline of the stock market. To encourage economic investment and stimulate growth, the federal reserve continues to cut interest rates. As a result, the interest rate on CD’s, bonds, and treasury bills continues to decline. Retirees often look at these types of conservative investments in retirement because of the interest income they provide. As interest rates on these investments continue to stay low, taxpayers will think twice about deciding to retire.

In summary, retirement is a complicated decision. Economic and financial factors often drive the decision to retire or keep working. Farmers should consider the many tax and economic issues and consult their tax advisor as they reach retirement age.

This article should not be construed as, and should not be relied upon as legal or tax advice.

Tyler Davis is a CPA who works for SVN Saunders Ralston Dantzler real estate as an asset manager and advisor. SVN Saunders Ralston Dantzler was founded by Dean Saunders in 1996 and is a leading agricultural land brokerage based in Lakeland, FL. Tyler also owns his own CPA Firm, Tyler Davis CPA where he provides tax preparation, writing, consulting, and research services. Tyler can be contacted at tyler.davis@svn.com.