Planning to trade up or out some farmland this year? Consult your tax adviser first. Since the Tax Cuts and Jobs Act is now law, Section 1031 Tax-Deferred Exchanges (also known as like-kind exchanges) are now more complex to execute.
“Under the new tax law, trading farmland is allowed using a 1031 exchange to defer the tax,” says Paul Neiffer, a CPA and principal at CliftonLarsonAllen and author of the blog “The Farm CPA.” “However, in order for it to be completely tax-free, it usually must include only land or items that constitute real estate.”
Non-Land Assets. Therefore, when land includes tiling, wells, irrigation pivots, etc., these items are likely to be treated as non-real estate. As a result, these assets will be fully taxable—even if you trade the property for other farmland, Neiffer explains. However, if the farmland you are exchanging for includes these same items at equal to or greater than what you are selling, the income tax effect will likely be a wash.
For example, Farmer Joe sells farmland worth $1 million. He purchased it for $100,000 several years ago. If Joe sells it for cash, the gain is $900,000 and subject to capital gains taxes. However, if he trades it for
other farmland worth $1 million, there is no tax due.
Now, let’s assume Joe put tile into the land at a cost of $100,000 and when the sale is done, the value is still $100,000. This means the farmland value is $900,000, which can be rolled over tax-free into the new land.
However, Joe will now owe ordinary tax on the $100,000 tile sale. This gain will be eligible for the new 20% Section 199A deduction (subject to possible limitations).
If the new farmland has tile worth $100,000, Joe can roll over the land gain tax-free, report a gain on the tile sale of $100,000 and fully deduct the tile on the new farmland of $100,000 using 100% bonus depreciation (or Section 179, if available).
State Laws Apply. However, if Joe is in a state that does not allow bonus depreciation and limits Section 179, he might now owe tax on the tile sale, but only be able to deduct about $5,000 of the new tile for state income tax purposes.
Even if tile is considered real estate under federal tax law, it is still Section 1245 property for income tax purposes. So, it will likely be fully taxable unless it is rolled into another like property.
“As you can see, 1031 exchanges on farmland are more complicated since farmland is usually not strictly land,” Neiffer says.