Insights

Farmer_Retirement_390x288

If you’re a farmer, you may have built up savings or used self-employed IRAs in anticipation of retirement. Still, your biggest asset is likely the farmland itself. To avoid capital gains taxes on the sale, you might consider a 1031 exchange.

 

The Tax Benefits of Using a 1031 Exchange to Sell Farmland and Secure Retirement Income

May 08, 2017

In many ways, the term farmer’s retirement is an oxymoron. An old joke says that farmers don’t retire, they just go to seed. Indeed, it isn’t just a job for most—it’s a way of life. As Paul Harvey immortalized with his So God Made a Farmer speech, a farmer is “somebody willing to get up before dawn, milk cows, work all day in the fields … then go to town and stay past midnight at a meeting of the school board.”

Given this dedication to your land, business, and community, the farming life can be a fulfilling one. And, if you’re like many, you’re continuing a family tradition that goes back several generations. You likely can’t imagine doing anything else, even in retirement.

But that doesn’t mean owning a farm doesn’t come with challenges. You may be faced with the ups and downs of agricultural markets or the lack of having someone willing and able to take over the farm. There might come a time when you look for something you’ve never considered before: an exit plan.

You may have built up savings or used self-employed IRAs (also known as a simplified employee pension, or SEP) in anticipation of retirement. Given how capital-intensive farming can be, though, your biggest retirement asset is likely the farmland itself. While leasing out farmland may be a viable solution, it can come with issues that you can’t take on in retirement.

Threats to a Retirement Portfolio: Taxes and Market Fluctuations

Selling the farm is another option. Proceeds from a sale can be used to fund retirement through a mix of stocks, bonds, and mutual funds that can provide income and growth of asset values.

Unfortunately, taxes on the gains may pose a major problem. Many family farms (and farmland) that have been held for decades come with a significant capital gains liability. Consider that a 300-acre farm that was inherited in 1990 with a basis of $425,000 may have a market value of $2.25 million today. Recognizing a gain of $1.825 million in a single year would bump you up to a 20% long-term capital gains tax as well as subject you to the 3.8% net investment income tax (part of Affordable Care Act funding). The federal capital gains tax alone could be over $400,000.  If you live in a state like California, you will also be subject to considerable additional state taxes.

Once the taxes have been paid, you still must endure the potential ups and downs of stock and bond markets. Consider that twice in the last 20 years even some blue chip stocks have seen a decline of nearly 50%, and yields on 10-year treasuries are currently less than 3%.

1031 Exchanges, Risk Management, and Estate Planning

Farmers who don’t want to pay capital gains taxes may consider using a 1031 exchange. The 1031 exchange allows a real estate holder to defer capital gains (and recapture) taxes on the sale of a property when those proceeds are subsequently invested in a like-kind property. Under the tax code, “like-kind” has a pretty ambiguous definition, so farmland could be sold and exchanged for other types of income-producing property, such as commercial real estate.

A key aspect of a 1031 exchange is that more than one property may be purchased, which might give the investor an opportunity to diversify their investment streams.

In a cruel irony, as science and technology have increased farming efficiency, the notoriously up-and-down nature of farming economics has become even more volatile. Where America was once considered the breadbasket of the world, the increase in foreign capabilities and recent strength of the U.S. dollar has seen the U.S. share of global grain markets drop to 30%.

While commercial real estate certainly has its own economic cycles, it also affords the opportunity to use professional management to assess risk and identify various markets and projects that may deliver a stable income stream. The tax benefits of real estate investing also allow for some of the income to be sheltered, mainly by depreciation.

In addition to providing you with the opportunity to transition to commercial real estate as an investment, the 1031 exchange comes with a significant estate planning benefit. The exchange can be used repeatedly to defer capital gains taxes throughout the lifetime of the investor. Upon the investor’s death, heirs will receive not only the property but a stepped-up cost basis, meaning that all capital gains and recapture taxes may be eliminated.

Plotting a Course of Action

Running a farm requires a business owner whose character is unmatched by many. As Harvey so eloquently described, it takes “somebody strong enough to clear trees and heave bails, yet gentle enough to tame lambs and wean pigs.” It takes “somebody who’d plow deep and straight and not cut corners.”

But, as the world has changed and time has marched on, not everyone is in the position to continue. For those who would like (or need) to exit farming and are one of the surprisingly many who have not identified a successor to run the farm, a 1031 exchange may provide the route to a secure and stable retirement. 

While the 1031 exchange is a valuable tool, the rules and regulations surrounding their use are complex. You should consult your tax and investment professional before making any decisions.

CWS Capital Partners has a nearly 50-year track record of successful real estate investment. Reach out to us to learn how our experience may be able to help you secure your retirement.

 

The information provided here is for your general informational purposes only.  It should not be considered a recommendation or personalized advisory advice.  CWS has made this third party information available from authors it believes are knowledgeable and reliable resources.  However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.

All investments involve risk including the possible loss of principal.  You should familiarize yourself with all risks associated with any investment product before investing.

Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.

Securities offered by CWS Capital Partners LLC are through an affiliated entity, CWS Investments. CWS Investments is a registered Broker Dealer, member FINRA, SIPC.


If you would like to receive an e-alert when a new blog article is posted, please sign up below.

E-Alert Lists