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.
Exchange of Bare Land Allows for Depreciation on New Property
Feb 12, 2011
We got the following question from a reader:
"If I 1031 a bare land parcel for a parcel with improvements can I depreciate the improvements?"
Before, I answer the question, lets review what "1031" means. 1031 refers to the section of the Internal Revenue Code dealing with tax-deferred exchanges. Under a 1031, a farmer can defer the gain on the sale of land by reinvesting the total proceeds into other like-kind real estate.
Some misconceptions about this is that a lot of taxpayers do not understand that raw farmland is like-kind with other real estate such as apartment buildings, retail strip centers, etc.
Another tricky part of a 1031 exchange is that normally the farmer needs to use a facilitator to handle the exchange during the whole process. I get many calls through-out the year from my clients saying that they sold a piece of property (without calling me first), got the cash and now want to know how to finish up the exchange so they can defer the gain. They are too late.
In order to have a proper 1031 exchange, the farmer must:
Enter into an exchange agreement with the facilitator,
Have the closing proceeds transferred at closing to the facilitator,
Identify the property they want to acquire within 45 days, and
Purchase that property within another 135 days or 180 days total.
There are no extensions on either the 45 day or 180 rule and if you miss any of these steps, you no longer have a qualified exchange. These rules are complex and you need to review them with your advisor.
For the current question, the rollover of the land into the land with improvements will allow the farmer to allocate their basis partly to the land, which can not be depreciated, and partly to the improvements which can be depreciated. Normally, this allocation is based upon the fair market value of the improvements over the total sales price times the basis in the property.