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March 2011 Archive for The Farm CPA

RSS By: Paul Neiffer, Top Producer

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.

It is Sales Price - Not Cash in a 1031 Exchange

Mar 21, 2011

We got a follow up question from our reader last week regarding Section 1031 tax-deferred exchanges:

"This is a follow up question to your answer about "Defer Gains" on March 16th Who normally is an "accommodator" and can that monies held by the accommodator be rolled to pay off our existing mortgage on our home. Does it have to be applied to a new purchase of property. ?? Thank You.."
 
The accommodator is like an escrow agent in that they will handle the proceeds from the sale of the property and hold them until new property is identified and acquired.  There has been some losses in this area with certain accommodators using the funds to invest in risky investments and you should make sure to investigate the accommodator and make sure that they use a segregated escrow account that does not co-mingle your funds with other funds.
 
With regards to the question on can the monies be used to pay off existing mortgages, etc.  The direct answer is no.  I will get get several calls a year regarding the sale of property and then rolling that sale into a new piece of property.  In almost every case, the taxpayer will tell me how much cash they are receiving and they think they only have to roll over the cash.  The correct answer is that they have to roll over the net sales price including all of the cash received.  Here is an example:
 
Sales Price $500,000 less mortgage of $250,000 equals net cash of $250,000.  The taxpayer has to roll over the full $500,000 including all of the cash of $250,000. 
 
Another common misunderstanding is that if you roll over less than the sales price, then the gain will still be deferred on a pro-rata basis.  For example, if you sell the property for $500,000 and your basis is $250,000, most taxpayers assume that if they do not rollover $50,000, then 50% will be non-taxable and 50% will taxable.  The correct answer is that 100% will be taxable.  Also, if you roll over less than 100% of your basis (in this case $250,000), all of the gain will be taxable.
 
To make a proper use of tax-deferred exchange requires the use of an accommodator and it should always be in conjunction with your tax advisor.

Defer Your Gain

Mar 16, 2011

We had a reader ask us the following question:

"When we sell our farm (that is currently cash rented out) is there any capital gains break if that "gain" is invested with a certain certain period of time."

When the real estate market was hot several years ago, many real estate investors took advantage of a tax-deferred exchange to defer their income tax on the sale of real estate.  Many of these investors rolled their gain over into farm land.

Now that the farm land market is heating up, many farmers may want to lock in their gain and sell their property.

They have two options:

  1. Pay the income tax at a federal rate of 15% (can be higher for recapture of depreciation on personal property and buildings),
  2. Defer the gain by rolling the sale of the property into other real estate.

 

Some sellers are able to do an immediate exchange of property with other taxpayers, however, the substantial majority of sellers take advantage of a tax-deferred exchange by using an accommodator to handle this transaction.  An accommodator will hold the funds while the seller finds other property to purchase and then transfer the funds to handle this purchase.

The key dates on this type of exchange is from the date you actually sell the property, you have 45 days to identify the property you want to buy and a total of 180 days to actually purchase the property.

I have many taxpayers call me after selling the property to ask about deferring the gain.  I will ask if they used an accommodator and they indicate they have already gotten the cash from the sale.  I then have to tell them that they are too late since any time you receive the cash personally, you can no longer defer the gain.

Remember, you must engage the accommodator before selling the property.

Also, you do not have to reinvest the proceeds in other farm land.  You can roll over the gain into almost any type of real estate such as apartment buildings, retail, office, etc.  If your land has substantial personal property such as irrigation equipment, etc. this gain can not be rolled into real property and may be taxable.

It's Not How Many Times You.....

Mar 14, 2011

Being in the middle of the busiest tax season that I can ever remember, we took some time out last week to attend a luncheon for the local economic development group.  The keynote speaker was one of the co-founders of the game Cranium.  His first story was about being in a taxi ride in Dallas a couple of years ago and how he got into a conversation with the cab driver.  They exchanged stories about their lives and the cab driver's last works were "It is not how many times you get knocked down, it is how many times you get up."

I think this saying applies to farming and life in general.  As we go along right now, most farmers are enjoying some of the best prices they have ever had, however, we must remember that sometime in the future, the farmer will get knocked down.  The important thing is to remember to get up and get up fast.

On a personal note, this last two weeks and probably the next week or so has been the busiest tax season I have ever had and it has reduced the amount of posts that I normally make.  Just want to let our readers know that once it dies down a little bit, I will get back to a more normal posting pattern.

A Guarantee is not S Corporation Basis!

Mar 04, 2011

 We had a reader ask the following question:

 "My farm operation is held in an LLC with S-Corp tax election. Last year I took a loan from the bank to purchase livestock and equipment.
 
I had to sign personal surety for the loan. Should the LLC default on payment, I stand to lose everything (You know the standard bank loan agreement).
 
 Because I signed personal surety for the loan and stand to lose everything on default, can I add the loan value to my LLC’s bases to offset tax losses?"

 

A farmer who owns a S corporation can only deduct losses to the extent of basis in the corporation.  Basis is primarily related to the amount of money the farmer puts into the corporation plus the earnings less the losses and the money the farmer takes out of the corporation.  However, the farmer can also have basis in any loans that they make "directly" to the corporation.

As in the above question, many farmers think that simply guaranteeing the loan that the corporation gets from a bank will create basis in the corporation.  This is wrong.  The loan must be made directly by the farmer to the corporation.  In this case, if the farmer had borrowed the money from the bank and then made a loan to the corporation with the necessary documentation of the loan, then they would have basis.

But simply guaranteeing a loan does not create basis.

 

 

 

Take Advantage of Tax Rate Arbitrage!

Mar 02, 2011

Many farmers created a corporation several years ago to operate their farm.  Many of these corporations have been converted over the years into S corporations.  However, one of the potential drawbacks is the retained earnings inside of the corporation that need to be distributed at some point in time.

Normally, S corporation basis is fixed at December 31 each year.  If the corporation has a large loss, the shareholders may not be able to deduct the loss on their personal tax return.  However, if the S corporation has retained earnings from its regular corporation period, the shareholders can elect to "distribute" this as a dividend and the technically recontribute the distribution back to the corporation as additional paid in capital.
 
The tax arbitrage feature of this strategy is that the dividend is taxed at a maximum rate of 15% (for federal purposes) and the ordinary loss that will flow through to the shareholders will be deductible at their marginal tax rate which could be as high as 35%.  For example, if the corporation distributes a dividend of $200,000, the tax would be $30,000, and if the taxpayer is in the highest rate, the loss that flows through would save $70,000 of taxes or a total of $40,000 in net tax savings.
 
If this applies to you, make sure to discuss with your tax advisor.  Certain elections need to be made on the S corporation tax return and all shareholders must agree.
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