This coming year may see more reform and changes than we’ve seen in quite some time. Tax reform related to 1031 tax-deferred exchanges can affect your clients, especially if they’re planning to sell income-producing property.
1031 tax-deferred exchanges have existed since 1921. These exchanges allow owners of business and investment properties to defer paying capital gains taxes if they reinvest all proceeds from the sale of a currently owned property (relinquished property) into a like-kind property (replacement property). Taxes on capital gains are not recognized on the property sale if the money is used to purchase another property. The payment is deferred until property is sold with no reinvestment.
What It MeaNS for the ag community
Many farm managers use tax-deferred exchanges to better manage their clients’ portfolios of land holdings, and they take advantage of opportunities to consolidate land parcels to enhance synergies and resource use. Agricultural properties, triple-net-lease investment properties, vacant and undeveloped land, oil and gas interests, mineral rights, water rights, air rights and easements in perpetuity are all examples of real property asset classes. Typically, these qualify as like-kind property for tax-deferred exchanges.
Changing this portion of the tax code could have significant effects on landowners, the demand for farmland and rural economies.
“Reducing this capital source equates to lower land values,” says Howard Halderman, AFM and president of Halderman Farm Management. “Lower land values negatively impact real estate taxes (lower assessed valuations) and rural counties as a result. This reduction will also hurt some producers’ balance sheets and impact their loans.”
Although no legislation has been introduced yet, members of Congress have expressed interest in a tax system overhaul, including repealing 1031 tax-deferred exchanges.
Rick Hiatt, AFM and founder of Hiatt Enterprises LLC, sees reforms to 1031 exchanges as threats to those who neighbor urban areas.
“Landowners are being pushed out and should be able to exchange land for rural properties and not incur a capital gains tax,” Hiatt says. “Exchange buyers bring new capital to rural areas; support healthy land values; help the farming population to expand operations; and pay real estate taxes to help rural counties and schools.”
Landowners use 1031 exchanges for asset preservation, consolidation of investment diversity, greater cash flow, relocation of investment, “stepped-up basis” for heirs, appreciation or leverage and building wealth.
How Future GEnerations Are Impacted
Dave Englund, AFM and senior vice president of farm and ranch operations for Farmers National Company, points out that a huge implication would be eliminating the “step up in basis.”
“We have large numbers of landowners who use this process to transfer land to the next generation. While this process also does not eliminate the tax, it delays it,” Englund says. “If it’s eliminated, we could see a large amount of land come on the market at once. This could ‘crash’ the ag land market and quickly drop land values. In turn, it would lower farmers’ equity in land, impacting their access to capital. This tax change could cause major problems in the ag sector similar to the 1980s.”
Ray Brownfield, AFM and president of Land Pro LLC, emphatically suggests that now is the time to contact your Washington representatives.
“Educate them on the importance these tax-deferred exchanges play in bringing new growth, tax revenue and capital to farming communities,” Brownfield says. “Changes could further tie the hands of landowners who won’t be able to sell a farm due to the large tax burden. This can be critical at a time when assets are transferring to the next generation.”