As has been pointed out time and time again, the 1031 Exchange is in place to help investors defer taxes on capital gains by allowing them to swap one type of real estate held for trade or investment for another (with assistance from a Qualified Intermediary). And most like-kind exchange discussions tend to center around commercial real estate, or residential property used to generate rental income.
But can a 1031 exchange be used for farmland or ranchland? While agricultural property is typically used for business operations or investment purposes, the land also contains non-real property (think crops and cattle) and can also hold residential properties (think farmhouses or ranch homes). Agricultural land might also include mineral and water rights.
So, the answer here is yes, it is possible for farmland or ranchland to be used in a 1031 exchange swap. But as is the case with many Internal Revenue Code regulations, there are a handful of caveats.
Ag Land Overview
First, the broad view. Agricultural land can generally be traded through a like-kind exchange as long as:
- It’s used for business purposes (you raise crops or your cattle grazes on it)
- It’s used as an investment (you lease the land to a farmer, who raises crops or grazes cattle, and pays you rent under a landlord-tenant agreement)
Furthermore, you don’t have to exchange your ag land for other ag land. “Like-kind” means you can swap that land into other real property (or properties) that are of equal greater value and defer those capital gains taxes.
Livestock, Crops, and Equipment
Once upon a time (before the Tax Cuts and Jobs Act of 2017), you could potentially replace or upgrade equipment used for crops or ranching through a like-kind exchange. The harvested crops and livestock were considered “property” and also possibly eligible for an exchange.
But not now. The 1031 Exchange is allowable only for real estate used for trade or investment purposes.
There could be a few exceptions to this rule. Improvements to raw land (such as adding irrigation or planting crops) might qualify as improvement costs in a like-kind exchange situation, though they could fall under the IRC’s Section 1245 rule. And while harvested crops aren’t “real estate,” unharvested crops and the land from which they grow, could count under the exchange rules. But before rushing to swap your corn field and its unharvested stalks for an apartment complex, check with your tax advisor and/or financial planner.
We’ve written about depreciation recapture, which is essentially a tax the IRS charges when an investment property is sold. We’ve also indicated that a 1031 exchange can help defer triggering a depreciation recapture.
But according to the IRS, land can’t be depreciated. This means no depreciation recapture if you should decide to sell your ranchland or farmland, right?
Not so fast. While land isn’t depreciated, you are required to recognize land improvements (such as added irrigation) or land structures (which might include a barn, grain silo, or warehouse) for depreciation recapture purposes. Some of these might fall under Section 1245 requirements and could impact what taxes can be deferred or what gains might be realized.
Again, it’s a good idea to talk to your tax advisor to eliminate any confusion.
Other issues to keep in mind with a farmland or ranchland 1031 exchange are as follows.
“Mixed use” might bring up visions of residences combined with retail. But when it comes to agricultural property, mixed use means part of the land is given over to a human domicile, while the rest is dedicated to business. That residence can be a farmhouse or even a barndomium. Either way, if you live in it for any length of time, it’s considered a primary residence. And primary residences, for the most part, can’t be traded under 1031 exchange activity.
- Segregate the personal residence from the farm’s or ranch’s total sales price
- Grant a tax exemption on the primary residence, as long as you’ve lived in the residence for at least two of the past five years
That exemption is $250,000 to single tax filers and $500,000 to those who file jointly.
Water, Minerals, Ditches
Farmland and ranchland involve more than crops and grazing grasses. There could be mineral rights involved, along with easements and water rights. Can these be part of a like-kind exchange as well?
Let’s take a look:
- In many cases, mineral rights and royalties could be considered real property for purposes of a like-kind exchange
- Water rights could also be eligible for exchange, based on state regulations
- Ditches, easements, and rights-of-way could also be eligible for 1031 Exchange swaps
While the 1031 Exchange process can be highly complex, using agricultural land as a relinquished or replacement real estate property has its own set of complexities. Because of this, we’ll reiterate what has been emphasized throughout this article—check with your tax advisor before embarking on a like-kind exchange of your farmland or ranchland.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. There is no guarantee that the investment objectives of any particular program will be achieved. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All real estate investments have the potential to lose value during the life of the investment. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. Costs associated with a 1031 transaction may impact investor returns, and may outweigh tax benefits.