If you are considering selling a farm or ranch, there are important tax and financial planning issues of which you need to be aware. Engaging in planning prior to a sale is critical for identifying these issues and for implementing strategies to effectively address them.
Your farm or ranch likely represents the majority of your net worth. Who you choose to list your property with is a critically important decision. Choosing the right ranch broker will not only help you obtain a top price for your property but will facilitate a smooth transaction. For a list of questions you can use as a guide for interviewing a farm or ranch broker, request Wealth Guide titled: Interview Guide for Selecting a Farm/Ranch Broker.
Taxation of Farm/Ranch Assets
Various tax rates and tax treatment apply to the different types of assets involved with the sale of a farm or ranch. How you allocate the sales price to the assets of your ranch will determine the tax you may ultimately pay. It is imperative that you and seek direction from your tax advisors when purchase price allocation is being negotiated.
Below is a summary of the four ways investors may be taxed on the sale of a farm or ranch:
- Federal Ordinary Income Tax: Taxpayers will be taxed at rates up to 39.6% depending on taxable income.
- Depreciation Recapture: Taxpayers will be taxed at a rate of 25% on all depreciation recapture.
- Federal Capital Gain Taxes: Investors owe Federal capital gain taxes of either 15% or 20% on the their economic gain depending upon their taxable income.
- New Medicare Surtax: The Health Care and Education Reconciliation Act of 2010 added a new 3.8% Medicare Surtax on “net investment income.” This 3.8% Medicare surtax applies to taxpayers with “net investment income” who exceed threshold income amounts of $200,000 for single filers and $250,000 for married couples filing jointly.
- State Taxes: Taxpayers must also take into account the applicable state tax. Montana currently has a top rate of 6.9%.
Tax Saving Tools for Selling Appreciated (or Depreciated) Property
Selling highly appreciated (or depreciated) property can result in a large tax bill. Taxes due on the sale may range from 20% to over 50% of the sale price depending on the cost basis of your property and how your property is owned.
Two financial tools are commonly used to defer or avoid tax on the sale of highly appreciated (or depreciated) property: IRC Section 1031 Exchange and IRC Section 664 Charitable Remainder Trust (CRT). Using one or a combination of these tools with a sale will save tax. Money that would have gone to paying tax can then be invested to help generate income for you and your family.
IRC Section 1031 Tax-Deferred Exchange
The IRC Section 1031 Exchange can be a powerful tax saving and wealth building tool that allows a taxpayer to sell property and purchase other property without currently recognizing capital gains tax on the sale. To quote the tax code: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment purposes if such property is exchanged solely for property of a like-kind which is to be held for either productive use in trade or business. For more information on 1031 exchanges, request our Wealth Guide titled: IRC Section 1031 Exchange: A Powerful Financial Tool for an Agricultural Family.
IRC Section 664 Charitable Remainder Trust
A charitable remainder trust (CRT), sometimes referred to as a capital gains avoidance trust, can be another powerful tool to defer or entirely avoid capital gains tax on the sale of appreciated real estate. In addition to avoiding tax on the sale of real estate, a CRT can also be used to avoid tax on the sale of other assets such as livestock, machinery and equipment. Combining A CRT and a 1031 exchange can be a powerful combination for preserving wealth. For more information on charitable remainder trusts, request our Wealth Guide titled: Charitable Remainder Trust: A Valuable Financial Tool for the Agricultural Family.
IRC Section 121 Personal Residence Exclusion
IRC Section 121 allows an individual to exclude up to $250,000 of taxable gain from the sale of a principal residence and a married couple filing a joint return to exclude up to $500,000 of gain. To help maximize the amount of tax-free cash you may receive from the sale of a farm or ranch containing the personal residence, one may include additional acreage with the home. Make sure to discuss this strategy with your real estate agent and CPA.
Real Estate Comprised of Multiple Separately Deeded Parcels
Farms and ranches are often composed of multiple, separately deeded parcels with varying cost basis figures. This typically happens as additional parcels of property are inherited or purchased over time to expand the capacity of the farm or ranch. If you are considering a 1031 exchange for part of the sale, a potentially effective tax-saving strategy is to obtain separate buy-sell agreements on each parcel so you can exchange the low-basis parcels and take cash out of the high basis parcels.
Owning Farm or Ranch real estate inside an entity
How you own your farm or ranch impacts the tax treatment and planning options available to you. Typical entities that own farm/ranch real estate include:
- General Corporation, also known as a “C” Corporation.
- Subchapter S Corporation
- Partnership/Limited Liability Company
While most people own real estate today in the name of an LLC, partnership or S Corporation, there are still those who own property in a C Corporation. When a C corporation sells appreciated real estate, it will owe tax on the profit at the corporate tax rate. When proceeds from the sale are then distributed to the shareholders as dividends, the shareholders will also have to pay tax on this income at their personal tax rate. Consequently, due to this double taxation, it is possible that the total tax due from the sale of appreciated real estate in a C corporation could easily exceed 50%.
Exchanging property owned by multiple partners/shareholders
Owning appreciated real estate in an entity can create problems when it comes time to sell the property. Challenges arise if there are multiple partners/shareholders with different goals upon sale. For example, if two people own appreciated land in partnership and one partner would like to do a 1031 exchange and one partner would like to pay tax and take the after-tax proceeds, there is a problem. The IRC 1031 Exchange provisions require that the entity selling the relinquished property must be the same entity taking title to the replacement property. So in this case, the partnership would have to do the exchange and each partner could not do his or her own exchange.
You and your family have worked hard to create the equity in your farm or ranch. When it comes time to sell, you need to work smart to preserve that equity and to make your money work as hard for you as you’ve worked for it.
Article provide by: Chris Nolt – Solid Rock Wealth Management
To view the complete Wealth Guide titled:What You Need To Know When Selling a Farm or Ranch, click here: http://solidrockwealth.com/wealth-guides/
About Solid Rock Wealth Management
Chris Nolt is the owner of Solid Rock Wealth Management and Solid Rock Realty Advisors, sister companies dedicated to working with families selling a farm or ranch. Their strategies are designed to save tax on the sale, to create passive income from sale proceeds and to maximize inheritance for children and grandchildren.
For more information, contact:Solid Rock Wealth Management 2020 Charlotte Street Bozeman, MT 59718 406-582-1264 www.solidrockwealth.com www.solidrockproperty.com
Securities and advisory services offered through Independent Financial Group, LLC (IFG), a registered broker dealer and investment advisor, member FINRA/SIPC. IFG, Solid Rock Wealth Management and Solid Rock Realty Advisors, LLC are not affiliated entities. This material was created to provide accurate and reliable information on the subjects covered. It is not, however, intended to provide specific tax or legal advice, nor is it an offer to buy or sell securities. Tax information provided can be sourced at www.irs.gov or your state’s revenue department website. Because individuals’ situations and objectives vary, this information is not intended to indicate suitability for any particular individual. The 1031 exchange and charitable remainder trust are complex tax codes and the services of an appropriate tax or legal professional should be sought regarding your individual situation.