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Capital Gains Taxes for landowners

When a landowner sells property, the difference between the sale price and the basis (the original purchase price plus improvements and less depreciation) is known as a capital gain, and the tax incurred upon it is known as capital gains tax. Among the many concerns of farmers and landowners, how to handle the capital gains taxes that can be incurred upon the sale of a farm or farmland is one of the most difficult issues to navigate. For many landowners, these taxes incurred by the sale of land can be crippling. The same is true of the next generation who may incur these taxed upon inheriting a farm.

In comments to reporters earlier this year, Ag Secretary Tom Vilsack spokes about finding ways to remove the tax disincentive that prevents landowners from selling land. Currently, he said, it’s more beneficial for landowners to hold onto farmground, and allow heirs to take over the land and sell it with the stepped-up basis, and thus avoid tax penalties. Vilsack spoke of the need to help offset those taxes in such land sales. Most landowners and farmers would agree.

Knowing this, President Obama’s latest proposal to raise the capital gains and dividend rate from 20 percent (23.8 percent when combined with the new taxes that resulted from the Affordable Care Act) to 28 percent for taxpayers with income above $450,000 for joint filers and $400,000 for single filers brought concerns for everyone, and especially landowners who will have a farm sale in their future. Specifically of interest to landowners is the president’s proposal to close the “trust fund loophole” that allows wealthier Americans to avoid capital gains taxations through stepped-up basis by letting wealthy people pass on appreciated assets to their heirs tax-free.

As such, rather than actualizing Vilsack’s desire to help landowners avoid debilitating capital gains taxes upon selling land, it would seem that the capital gains tax would be higher, and the possibility of utilizing the stepped up basis would be eliminated altogether. According to DTN Ag Policy Editor Chris Clayton, farm groups have largely supported stepped-up basis as a way to transfer the farm within the family without the heirs getting hits with higher capital gains taxes, should they choose to sell the property.

While this news may be troubling, immediate chances that these new tax policy proposals will pass are very small, considering Republican control of both the House and the Senate.

However, capital gains taxes are still high, and having a plan in place to avoid incurring ruinous taxes—or passing them onto one’s children—is highly recommended. Consult a land manager and a tax consultant to keep on top of the latest rates and scenarios that could help mitigate such an occurrence. Researching the possibility of a 1031 exchange may be a good consideration as well.

Do you have concerns about capital gains taxes and your land? Feel free to contact a UFARM land manager; we’re glad to listen to your concerns and implement a strategy for your farm asset.

Sources consulted: Biebl, Andy. “Whither Capital Gains Rates?” DTN The Progressive Farmer. DTN. 04 Mar. 2015. Web. 25 Mar. 2015. Clayton, Chris. “White House Tax Plan Targets Capital Gains, Stepped Up Basis.” DTN The Progressive Farmer. DTN. 18 Jan. 2015. Web. 25 Mar. 2015.

1031 ExchangeAt 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.

 

 

 

rising interest ratesAs we roll into 2014, farmers and landowners are looking ahead to see what the new year will mean for commodity prices and land values. One of the main indicators affecting these prices is the interest rate. Producers wonder whether they will see an increase in interest rates in 2014, and if so, how that will ultimately affect their farming operations.

After nearly a decade of burgeoning land values resulting from high commodity prices combined with extremely low interest rates, 2013 and 2014 might bring about a market correction in this area, and it seems as if the value of farmland has peaked for the time being. The first half of 2013 saw slight increases in the interest rate, along with falling commodity prices. As a result, land values seem to be leveling off.

In a report entitled, “Land Values Peaking Out—But Not Down,” Sterling Liddell, a senior analyst at Rabobank Food & Agribusiness Research and Advisory (FAR), predicts that while commodity prices will likely be lower in the coming year, they won’t be low enough for long enough to substantially affect land values in the short term.

However, Liddell also notes that the greatest risk to land values is higher interest rates. Since interest rates can hardly go any lower than they have been in recent years, it’s a widely accepted assertion that they will inevitably rise. When might this increase take place? Based on current Federal Reserve Policy, substantial increases aren’t forecasted until later 2014 into 2015. According to analysts at the web-based Farmland Investor Center, “More specifically, the Fed has said that it will hold short-term interest rates near zero as long as the unemployment rate remains above 6.5% and inflation expectations one to two years out remain under 2.5%. The Fed projects the unemployment rate could fall to 6.5% in 2014. But most Fed officials expect to hold off on a rate increase until 2015, according to an internal assessment of monetary policy.”

While it’s widely known that higher interest rates negatively affect land value, what’s less known is to what degree. Jeff Caldwell of Agriculture.com postures that land values are likelier to respond more sharply to interest rate increases in the current market climate, since a market indicator known as the capitalized value of land is so high. “The higher the capitalized value, the more the land is being influenced by factors like low interest rates, thereby making it more susceptible to value declines when those factors change.”  Thus, Caldwell posits that a rise in interest rates would affect land values more quickly and more sharply now than it might when the capitalized land value is lower.

In the meantime, no matter when or to what degree interest rates increase, it’s more important than ever for farmers and landowners to keep a close eye on their input costs and marketing as they’re faced with the likelihood of land value decreases and interest rate increases in the foreseeable future.

If you would like to evaluate your options as a land owner, contact a UFARM professional land manager. Consultations are free.

 

Sources: “Falling Land Values? Watch Interest Rates.” Web log post. Agriculture.com. Caldwell, Jeff. 27 Aug. 2012. Web. 02 Jan. 2014.
“Era of Record Low Mortgage Rates Ending as Fed Begins Paring Back Bond Purchases.” Web log post. Farmland Investor Center. N.p., n.d. Web. 02 Jan. 2014.

“Don’t sell the farm,” or “I wouldn’t bet the farm on it,” are well-known idioms, and for good reason: They are a very fair representation of the high stakes that accompany such a venture. Over the last decade in Nebraska, with a growing number of farmers and landowners at an advanced age, knowing how to go about selling their farming enterprises or passing them down to their children is fraught with difficulty, and there are many issues farmers must take into account when going about estate planning and passing along their life’s work to the next generation.

Selling the Family Farm

One such issue that must be taken into account is quite obvious, but often overlooked: Do the children actually desire to carry on the family farm? Often, this fact is simply assumed, and parents make arrangements early-on, only to find out too late that the sons or daughters have very little interest in farming. If this is the case, it is in the best interest of all involved that they hire a professional farm management company or sell the asset to an interested party, so that the money is able to benefit the family and allow them to pursue their own aspirations.

Many experts advise that parents sell—rather than gift—the farm to their kids. This ensures that the kids do, in fact, desire to farm since they are buying it with their own capital. This way, there is “skin in the game,” and the farm benefits as a result.

Perhaps the largest factors affecting the sale of farms are the tax consequences. Navigating the myriad federal and state capital gains, estate and inheritance taxes is tricky. Inheritance taxes, aka the “Death Tax,” can be an especially difficult tax to handle, especially for small businesses and for family farmers and ranchers. Often, those on the receiving end of farmland from the previous generation are forced to sell that land in part or whole just to pay the taxes. Nebraska is one of only six states nationwide that has a separate state inheritance tax, so Nebraska farmers must contend with this extra tax as well. Experts emphasize the importance of seeking sound legal counsel as well as to obtain advice from those with expertise in farm management in order to minimize the often crippling tax burdens that can accompany the inheritance of the family farm.

Above all, it’s important for farmers to have a plan. It’s never too early to start planning one’s own future business succession, and it’s simply another part of farm management.  If working with a farm  management company, have copies of reports sent to adult children, so they can learn about the farm before the parents are gone. A lack of planning can put huge amounts of stress on families, and even sometimes tear them apart due to bickering among siblings about what to do about the farm or land that they’ve inherited, in part or whole. This plan will need to be reviewed often, and perhaps will change many times due to varying outside factors, but at least there will be a plan in place to guard against such instances.

If you need assistance managing your farm or transitioning your land for the future,  please don’t hesitate to contact us at United Farm and Ranch Management .