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1031 Tax Free Exchanges for Farms, Ranches and Investments

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Real Estate that qualifies for a 1031 tax free exchange is property that was purchased as an investment.  Very specific rules must be followed to sell or exchange a property and avoid any capital gains tax .  I am not a CPA or tax professional, nor do I play one on TV, but I am a real estate professional that has handled many of these exchanges and want to offer what I know.  If you plan on a 1031 exchange in the future I would suggest you also talk with a tax professional about your particular tax situation.

The 1031 option has always been a very popular way of selling one ranch to buy up and defer any taxes.  While the capital gains tax rate was 15%, most people would just pay the tax because they knew it would probably never be that low again.  Now that the rate is at a minimum of 20% + depending on your income level, an additional 3.8% medicare tax can be added + whatever the Obamacare tax is taking the rate to as high as 28.5%.  The 1031 is becoming very popular again and a great way to put paying that tax down the road to a later date. 

What qualifies for a 1031 tax free exchange?  Any property that was held for the productive use in a trade or business or for an investment qualifies for deferring capital gains.  Property in a 1031 tax deferred exchange is considered to be exchanged rather than bought or sold.  Sometimes you will hear people call it a “Like Kind Exchange”.  This does not mean if you sell a ranch you have to exchange it for another ranch, it only means you have to exchange one real estate investment for another.  This could be a ranch for a commercial strip center or vise versa. 

A major factor that most people do not know is when conducting a 1031 tax free exchange you MUST EXCHANGE DEBT FOR DEBT and INCOME FOR INCOME.  It is not up to you to decide what is capital gains so the rule is simple.  You must invest the whole amount to avoid any tax at all. That means if you have a loan against the property you are selling, you must either pay that loan off with cash you already have or borrow the same amount and invest the total amount of cash received from the sale. 

It is really easy to make the execution of an exchange seem a lot more complicated than it needs to be.  I will try and explain with the following steps.

1)   Simply identify the property you are selling prior to closing as a possible 1031 tax free exchange.  The identification is done in a couple of ways but the first step is to indentify it in the sales contract.  I usually place in special provisions the following language “Buyer or Seller may conduct a 1031 tax free exchange at no additional cost to either party”.

2)   Identify a qualified intermediary to hold the proceeds.  This is required by the IRS to insure that the seller does not receive or have access to the funds after the closing of the property being sold and before the property being purchased is purchased.  Many firms offer this service and the prices vary so it is best to compare before deciding whom to use.  The qualified intermediary will receive the funds from your closing and hold them until the purchase property is closed and they will help facilitate the transfer of all monies from one title company to another.

3)   Once you close on your sale, you have 180 days to complete the purchase of the replacement property.  During the first 45 days of the 180 days you must identify up to 3 potential replacement properties.  You then have 135 days to purchase and close on 1 or all 3 of the properties you identified, but property must be on the identification list or it doesn’t count.

You are strongly encouraged to contact and develop a relationship with an experienced farm and ranch or commercial broker who can assist you in structuring such a sales transaction or acquisition.  For more information on South Texas ranches, farms or hill country property please contact Brush Country Real Estate at www.BrushCountry.com or Brad Boyd at brad.boyd@brushcountry.com.

 

 

 

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