Every property investor wants to build wealth. Land as an investment keeps gaining in value. When it’s time to sell a farm or ranch, consider using a 1031 or like-kind exchange as allowed by the tax code. Let’s talk about how you can defer all or part of your capital gains taxes by filing for a 1031 exchange. They are frequently referred to as Starker Exchanges.
IRS Code 1031 exchanges allow for deferred capital gains taxes on investment land. For ranch management to be successful, it’s imperative to utilize tax write-offs and tax savings. Even the small investor can use 1031 exchanges to build wealth. So, let’s see how you can benefit from this tax code.
What is a 1031 Exchange?
Briefly, Section 1031 of Internal Revenue Code allows investors to defer capital gains taxes on specific real estate transactions. The proceeds of the real estate sale(s) must be shortly reinvested in like-kind properties. All rules of a 1031 exchange need to be followed exactly. If not, then capital gains taxes cannot be deferred.
Farm and Ranch Investment Land
Farm and ranch properties fall into the required same use categories. However, as business use, it could be exchanged for other real estate. Although the land as an investment comes under section 1031, an owner’s residence may fall under section 121 for taxes. Anything taxed as real estate will count, even if you’re getting a partial 1031 exchange. Look at unharvested crops, water rights, and mineral rights.
Advantages of 1031 Exchanges
When you understand the process, you can take advantage of 1031 exchanges. As mentioned, you can grow wealth, but this tool can also help investors diversify and move investments. For example, investors will:
- Save capital gains taxes on the proceeds of sold properties
- Leverage additional equity to purchase a more valuable replacement property
- Increase income by trading up to a property that produces more income
- Trade a high-maintenance for a low-maintenance land investment
- Easily acquire a variety of properties
- Diversify a portfolio to reduce risk
- Select property types with maximum depreciation benefits
- Plan an estate
Rules of 1031 Exchanges
The Internal Revenue Service (IRS) lays out multiple rules in Section 1031, adding a level of complications or exceptions. Variables change depending on the investments involved.
Sample rules include:
- Investors need to interview and hire a qualified intermediary (QI). As escrow, the QI holds the proceeds from the sale of the relinquished property until the replacement property or closes.
- The QI is neutral and cannot be related to any transaction parties.
- Property must be used for investment, trade, or business that is relinquished and exchanged for a like-kind property.
- Investor must own the existing investment property for at least one year.
- To defer all the capital gains taxes, the total proceeds of the relinquished property go toward the replacement properties.
- If the replacement property costs less, then you will only pay capital gains taxes on the difference or the “boot”. This is a partial 1031 exchange.
- Within 45 days of relinquished property sale, up to three (or even more) replacement properties must be identified and purchased within 180 days.
- 200 percent rule
- 95 percent rule deals with unlimited number of properties if buyer pays 95 percent of all
1031 Exchange Timeline
Originally, land exchanges all needed to take place at the same time. Some simultaneous exchanges still happen. Sellers must compile information on the relinquished property. (What is it, when was sale, amount of sale, how it is held, use of property, mortgage balance, equity position, current escrow, date of closing)
More often, however, investors take advantage of a 180-day window allowed for the delayed exchange, reverse exchanges, and construction or improvement exchanges.
Delayed 1031 exchanges allow 45 days from the date of the relinquished property close for the identification of potential replacement properties. The investor must report in writing the complete address and legal description, purchase price, down payment, and loan amount. In addition, communications must state the percentage of interest in the property being acquired.
Investors must buy the replacement properties within 180 days of the first sale.
1031 Exchange as Estate Planning Tool
Property acquired through a 1031 exchange may be will to an heir. When the heir takes possession of the property, the value will be current fair market value and your heir will not have to pay any capital gains taxes on the property. The 1031 exchange can also be used to divide proceeds and assure up to three heirs of separate property inheritances.
Rules Vary Slightly by State
The 1031 exchange is great can work across state lines and rules may vary slightly from state to state. Simply hold properties which are similar in nature properties for business or investment purposes.
Qualified intermediaries must carry insurance. In Colorado, the QI must maintain a fidelity bond of $1 million or more and an errors and omissions policy of at least $250,000. If the Colorado escrow account holds more than $250,000, they need your written authorization for a withdrawal from the escrow account.
Time to Upgrade Land Investments with a 1031 Exchange?
Is it time to upgrade your investment land? If you are planning to sell farm or ranch investment land, you may qualify for the 1031 exchange to defer the capital gains taxes. When you meet the rules for 1031 exchanges, they can provide substantial benefits for ranch management to consider. Does a fishing property or hunting ranch sound more in line with your needs today?
A 1031 exchange timeline can be as easy as 1, 2, 3:
- Sell and relinquish a property
- Identify a like-kind property within 45 days
- Purchase the replacement property within 180 days
Your experienced ranch real estate broker, tax consultant, attorney, and the QI can guide you through the process. We hope this information give investors a sense of what is a 1031 exchange to help bolster your portfolio.
Ranch Brokers – 1031 Exchanges
Call Harrigan Land Company at (303) 908-1101. We hope this information about the 1031 exchange tax code helps you to make the most of your property investments. Contact us to discuss farm and ranch exchanges in Colorado, New Mexico, Wyoming, Utah, or Montana.