A successful 1031 exchange process requires strict adherence to deadlines and an understanding of regulations. One example is exchanging your relinquished property for a replacement property (or properties) of equal or greater value.
And yes, exchanging into (or out of) farmland is possible. But how long can you wait to conduct that exchange after selling that farmland?
There are a couple of issues here. First, selling that farmland before moving forward on a 1031 exchange is considered a “straight sale,” which will likely trigger a taxable event. Second, if you decide to sell that farmland after initiating (and concluding) a like-kind exchange, it’s a good idea to hold on to that property for a specific period.
The Straight Sale
A straight sale aims to strike a deal with a buyer, determine an escrow period, and close the transaction. There are many reasons why a straight sale could be more advantageous than a 1031 exchange. These can include timing, inability to find the right replacement property, no access to investment capital, and the very stringent IRS rules.
Furthermore, is it possible to move forward on a 1031 exchange after a straight sale? In most cases, no. The reason is that you’re not allowed to have possession of the proceeds from your relinquished asset, in this case, farmland.
If you’re considering selling your farmland through a straight sale, be aware that you’ll likely be on the hook for capital gain and depreciation recapture taxes.
The 1031 Exchange
Selling farmland (the replacement property) is possible after completing a 1031 exchange. But it’s a good idea to allow plenty of time between the exchange’s conclusion and the straight sale of that property. The IRS carefully monitors timing when it comes to like-kind exchanges.
If you decide to sell the replacement property immediately after the exchange’s completion, you could lose out on any potential tax-deferral benefits. This is because the IRS might not consider that you’re holding on to the property for investment purposes but rather to “flip” it.
Another challenge is that the IRS doesn’t mention a specific timeline for holding that replacement property. In 1984, the IRS issued a Private Letter Ruling indicating that two years would be considered an acceptable property holding period on real estate held for investment.
Timing is Everything
A successful 1031 exchange requires specific timing and an understanding that the farmland you exchange out of (or into) must be held for investment purposes. As such, you can’t conduct a like-kind exchange after a straight sale. Furthermore, if you want to sell your farmland after concluding a 1031 exchange, wait for at least two years.
Because of the 1031 exchange’s complexities, be sure to work with a professional familiar with the deadlines and procedures.
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.
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's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
