At some point during any farmer or landowner’s lifetime, they will likely be involved with the sale and acquisition of land. Deferring the capital gains tax on the sale of land to a later date by purchasing more land—in what is known as a 1031 exchange—is a common practice that has been employed for many years. Several proposals by the federal government to significantly alter the 1031 Section of the IRS code have many in the real estate business wondering about the future of 1031 exchanges, and how this might affect multiple industries, including farmers and landowners.
A 1031 exchange is a very useful tool for investors. In technical terms, “A 1031 exchange allows an investor to defer the recognition of capital gains when exchanging one appreciated investment property (the ‘relinquished property’) for another ‘like-kind’ investment property (the ‘replacement property.’)” In most 1031 transactions today, the investor employs a qualified intermediary (QI) to facilitate the sale of the relinquished property to one party and the purchase of a replacement property from another party. The replacement property must be equal to or greater in value to the relinquished property. The capital gains are thus deferred to a later date, when the replacement property is sold or transferred with non-like-kind property.
As such, 1031 exchanges are not tax loopholes; they are merely a deferred payment of taxes. Commercial real estate expert Scott Saunders explains, “The essential logic is that the investor, in exchanging one appreciated property for another like-kind property, has not realized the gain inherent in the relinquished property. The investor has merely changed the form of his investment.” Thus, since no profit is realized in the transaction, there is no premise for taxation.
It is no secret that 1031 exchanges are friendly to investors, businesses and business owners, farmers, and landowners. The advantages of 1031 exchanges are numerous. They make sound business sense, helping investors grow, change locations, diversify and expand, thereby creating jobs, further financial opportunities and economic stimulus to a wide array of other economic sectors.
Consequently, it is troubling to many that the federal government is looking to alter—and in some cases, eliminate—1031 exchanges, in order to increase federal tax income. Two separate proposals, one by former Democratic Senator and current China Ambassador Max Baucus and another by US Rep. Dave Camp (R-MI), would eliminate all 1031 tax exchanges. President Obama’s latest budget proposal would limit the deferred taxes in a 1031 exchange to $1 million dollars per taxpayer per taxable year beginning January 1, 2015.
Of course, should these proposals pass, the effect would not, in fact, produce more federal tax revenue. In reality, the likelihood that investors would simply hold onto properties rather than sell without the ability to defer tax payment through 1031 exchanges would greatly increase. Accordingly, the beneficial economic ripple effects to other financial sectors would lessen as well.
Saunders urges taxpayers and voters to educate legislators on the many benefits that 1031 exchanges offer in order to put a stop to the potential elimination of 1031 exchanges.
Are you looking to sell land, and are wondering about how a 1031 exchange would work for you? Are you concerned about how these potential tax changes might affect you and your land? Contact a UFARM representative with your concerns—they are glad to help.
United Farm and Ranch Management (UFARM) is a Nebraska-based company devoted to meeting landowners’ needs. UFARM offers a full range of Nebraska land management services, including real estate sales, rural property appraisals, consultations and crop insurance. UFARM has operated in Nebraska since the early 1930’s. Contact Us.
Sources consulted: Saunders, Scott. “1031 Exchanges Face Uncertain Future.” Rebusiness Online. 06 May 2014. Web. 02 Sep. 2014.