In times of tight margins, every purchase must have a purpose with ROI top of mind. As you optimize your equipment, crop inputs, farmland and business intellect for the year ahead, take the time to plan your work, and then you work your plan.
We continue to receive questions regarding how tax-deferred exchanges of farm real estate are taxed. The Tax Cuts and Jobs Act of 2017 eliminated the ability to defer tax on personal property but retained it for real property.
However, farm real property is not comprised of just one type of tax property but rather three types. Land is taxed at capital gains rates if it has been owned for more than a year. Land can be exchanged for any other real property including the following two types of properties.
To fully defer the gain on land, you must reinvest the net sales price and all of the cash.
Section 1250 Property
This property is farm buildings such as a machine shed, barn, or corporate provided housing. It does not include livestock-specific structures or buildings used for storage of farm commodities.
If this property has been subject to accelerated depreciation in excess of straight-line, then that portion must be reinvested in Section 1250 property. The portion related to straight-line depreciation can be reinvested in any real estate.
Section 1245 Real Property
A farm can have many types of Section 1245 real property. To fully defer the gain on this, you must fully reinvest the gain in Section 1245 real property. Again, it does not need to be exactly the same type of property but must be Section 1245 real property.
A Few Examples
A farmer who sells land with improvements must be careful of how tax might be deferred under Section 1031. For example, Jane sells a quarter section of land for $1 million. Her basis is $100,000. The only real restriction is that she must reinvest the $1 million into real estate. It could be additional farmland, an apartment building, land with a shop or grain bins.
Variation 1 - On the land is a machine shed with a value of $250,000. She deducted the original cost of $200,000 using bonus depreciation and this is $150,000 greater than straight-line depreciation. She must reinvest at least $150,000 into 1250 property to fully defer that portion. The remainder can be reinvested in any real estate.
Variation 2 - On the land is a grain system which is valued at $300,000. To fully defer the gain, she must buy Section 1245 property worth at least $300,000. This could be land with trees, tiling, or other types of Section 1245 real property. Some common types are listed below. Again, the remainder needs to be invested into real estate.
Variation 3 - Jane sells land with a machine shed worth $250,000 but buys land with a grain system worth $250,000. A grain system is not Section 1250 property, therefore, the $150,000 gain (in our previous example) on the machine shed is taxed, however, the grain system can now be fully deducted using Section 179. Or she can deduct about 65% using bonus depreciation. The gain is not subject to self employment (SE) tax while depreciation reduces SE income. When bonus depreciation was 100%, we often preferred the gain being taxed since 100% bonus depreciation would offset the gain and reduce self-employment taxes.
Whenever a farmer sells land that includes improvements, it requires careful review of how a Section 1031 exchange could potentially defer the gain.
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