One of the first things an owner should consider when looking to sell their ranch or sporting property, is the tax consequences, as selling an asset can create a taxable event and the last thing an owner wants is to be hit with a big tax bill if it can be deferred. Therefore the first step would be to contact a CPA or Tax attorney.
A CPA or tax attorney can assist in determining potential tax consequences from the sell of the property. In simple terms, this is determined by the length of time the asset has been held and the current value of the asset minus the basis in the property. Basis is the value of the asset when it was acquired. It is very possible that the taxes due would be minimal if the basis is close to the current value of the property.
For example, maybe the owner recently inherited the property in which case they receive a step up in basis to the value of the property at the time it was inherited. Since the sale price and the new basis are very close, the taxable amount (sale price – basis) is small and therefore most likely the tax owed would be minimal.
But let’s say the owner inherited the property 50 years ago and the value of the property has appreciated dramatically. In this case, the taxable amount would be considerable and the owner could be facing a sizable tax bill. So what can an owner do?
One of the most common tools is the 1031 Tax Deferred Exchange so called because it is outlined in the Internal Revenue Tax Code, Section 1031. Notice it says “deferred” and not avoidance. This is because a 1031 exchange simply allows the owner to defer paying taxes to some time later in the future by purchasing a replacement like kind property.
In the simplest terms, a 1031 must follow certain guidelines. These rules are the very basic guidelines and an owner should always consult with tax and legal professionals prior to the sale of large assets.
- Replacement property must be like kind
- Replacement property must be identified within 45 days after closing on the relinquished property (there are rules for identification of replacement property – consult with legal counsel and/or a Qualified Intermediary)
- Replacement property closing must occur within 180 days of closing of relinquished property (this time can be shortened depending on tax filing deadline)
In addition, the relinquished property must have been held for investment. Therefore a primary residence would not qualify for a 1031 exchange.
This raises a very common scenario in regards to family ranches. The family owns the ranch and also uses the ranch home as its primary residence. Can you do a 1031 exchange? In short, yes however it must be done in such a way so that the sale is essentially split into 2 transactions. 1 being the home and the other being the ranch land and operating assets such as barns, corrals, etc. This would allow the owners to 1031 exchange the ranch land and operating assets as well as exclude the value of the home under Section 121 so long as:
- The home has been used as the primary residence for 2 of the last 5 years.
- The exclusion has not been used in previous 2 years.
And the exclusion is limited to $250,000 if single or married filing separately or $500,000 if filing jointly.
There are many tools and procedures to help reduce or defer tax liabilities and 1031 exchanges is one of the more commonly used tools in regards to selling ranches. There are very creative ways to legally conduct a 1031 exchange and this article only touches on the very basics.
Always consult with your tax and legal professionals and do not wait until the day of closing or worse the day after closing. If you would like additional information on 1031 Exchanges feel free to contact John Hayter.
**disclaimer – This is not to be consider legal advice and is for informational purposes only. Always consult tax and /or legal professionals for real estate legal and financial matters.