The Farm CPA
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
Cash Received Does Not Equal Gain
Jan 23, 2014
We got the following question from a reader:
"I bought 3 farms in recent years. Is there a way to sell one or part of one and pay the other 2 off without paying tax on that money?"
I can give a general answer to this question, but without having the actual facts of each farm's cost and fair market value, it will be difficult to give a full answer to the reader.
In general, when you sell property, you are only taxed on the amount of gain the property generates, not the cash received. I get the following common conversation many times each year.
A client will come in and tell me they sold some real estate and since they only got $20,000 of cash, they "know" that the gain is only $20,000 and tax will be about $3-4,000. However, after discussing the matter with them, we find out they have re-financed the property two times; pulled out $200,000 of equity; and rolled over a Section 1031 gain of $300,000 into the property. After doing the final calculations, I have the sad task of telling the client they now owe $100,000 of capital gains taxes and they only have $20,000 of cash. This sometimes becomes a heated discussion since they can't seem to understand how the gain can be higher than $20,000 of the cash they received. After explaining the facts of their situation, they usually end begrudgingly understanding it, but needless to say, they are not happy about it. Our better clients usually call us before selling real estate to determine what the gain and tax actually are.
Now for the reader's situation. I am assuming that each of his farms have increased in value since this is most likely the only way to sell one and pay off the other two. Now if the property has increased in value enough, he may be able to get cash to both pay off the debt of the other two and PAY the income taxes, but most likely not get by without paying any tax.
For example, assume he bought each farm for $1 million and had debt of $500,000 on each property. If the value of one farm has increased to about $1,750,000, he could sell that farm, pay off the debt of $500,000; pay income taxes of about $175-200,000; and have at least $1 million to pay off the $1 million of total debt on the other property.
Now some farmers think they could use a Section 1031 exchange to sell their farm, rollover the gain into other farmland, etc. However, when you sell farm land using a Section 1031 exchange, you must roll over all of the cash received and not pay off debt of other farm land owed.
The bottom line for our reader is that most likely he can sell the farm land to pay off the debt on the other two farms, but he will owe some taxes too.