Yup, it’s tax season.
If you sold your ranch in 2022, now’s the time to work with your tax advisor to help you preserve as much of your sales proceeds as possible and avoid steep tax penalties when you file with the IRS.
And there’s some good news — there are several perfectly legal and ethical financial tools in place to help you pay less in taxes and preserve wealth. But let’s first focus on the four ways you might be taxed on the sale of your ranch or farm property. This will help you determine how to best deal with the taxes and, hopefully, protect the bulk of your sales receipts.
Four ways you can be taxed on the sale of your ranch
- The federal ordinary income tax, which could amount to almost 40 percent, depending on your taxable income. This is the base tax that everyone is subjected to, and the tax rates change depending on the taxable income of the taxpayer.
- Depreciation recapture. Depreciation recapture is defined as the gain earned when depreciable capital property is sold and is reported for tax purposes. If the sale price of the property exceeds its tax basis, the difference is what is “recaptured.” It’s that difference upon which a seller is taxed.
- Federal capital gains. This tax can come to between 15 and 20 percent, depending on the seller’s taxable income and how much profit was derived from the sale of ranch property.
- The new Medicare surtax, which was instituted in the Health Care and Education Reconciliation Act of 2010. This added a 3.8-percent Medicare surtax on net investment income, and it applies to taxpayers whose net investment income exceeds $200,000 for single tax filers or $250,000 for married couples who file jointly.
Don’t forget, too, that you’ll likely pay state taxes on the sale of your ranch. That’s an important consideration you and your tax advisor shouldn’t overlook.
How can you reduce your tax burden from the sale of your ranch?
One of the best ways to preserve your wealth and pay less in taxes is by the use of a Section 1031 Exchange. This tool essentially allows you to sell your ranch property and then purchase other property without having to acknowledge the capital gains on the ranch sale, so long as the proceeds from the sale are used to purchase “like-kind” property that you intend to use for business purposes. If you’re planning to use your proceeds to buy another property, take a look at ranches for sale and find a property that meets the IRS’ “like-kind” requirement. This can be an excellent way to avoid capital gains taxes, which can be crippling.
If your farm or ranch consists of several individually deeded parcels with different property values, a 1031 Exchange might be a great tool to consider — you can obtain several buy-sell agreements on different parcels. This allows you to exchange the lower-valued parcels and pull cash out of the more valuable transactions.
Another way to reduce your tax burden from the sale of ranch property is to use a charitable remainder trust, or a CRT. Some tax advisors use this tool to help ranch sellers avoid capital gains taxes. It can be used to defer or even avoid capital gains taxes on real estate that appreciated enough to move the capital gains needle. It’s also possible to join this tool with the above-mentioned 1031 exchange and further reduce the overall tax burden. If your ranch sold at a nice price, but that price triggered significant capital gains, check with your tax advisor to see if a CRT coupled with 1031 exchange will work for you and your financial situation.
Finally, IRS tax code Section 121 allows an individual to exclude up to $250,000 of taxable gains from the sale of their ranch property, so long as that property is their primary residence. That number jumps to $500,000 for married taxpayers who file jointly.
The bottom line
Buying and selling ranch property is part of the ranch management process, and, like it or not, so are taxes. It’s important to choose the method best for your financial situation when you settle up with Uncle Sam. You should work with your tax advisor to incorporate all the tools legally at your disposal to reduce your tax burden and protect your wealth.
As they say, the only certainties in life are death and taxes. With the right advice and the right plan, the latter doesn’t have to be overly burdensome.
