Tax Savings Available on the Sale of a Ranch
By Chris Nolt, Solid Rock Wealth Management
Taxes due on the sale of a highly appreciated Wyoming ranch can be 20 percent or more of the sale price. Fortunately, financial tools exist that can help defer or avoid these taxes. To benefit from these tools, however, you must engage in planning prior to a sale.
Two financial tools are commonly used to defer tax on the sale of highly appreciated or depreciated property: IRC Section 1031 Exchange and IRC Section 664 Charitable Remainder Trust (CRT). Using one or a combination of these tools with a sale can save tax that would normally be due upon sale. Money that would have gone to paying tax can then be invested to help generate income for you and your family.
The IRC Section 1031 Exchange
The IRC Section 1031 Exchange is a powerful tax saving and wealth building tool available for people selling highly appreciated real estate. A properly structured 1031 exchange allows a family selling a ranch to sell land, to reinvest the proceeds in other real estate, and to defer capital gain taxes and the new Medicare (Obama Care) 3.8 percent tax on net investment income.
Besides tax-deferral, there are other potential benefits for a taxpayer who successfully performs a 1031 exchange. Some of these include cash flow, eliminating active management and wealth building.
Increased cash flow can be achieved as lands are exchanged for other types of investment property that pay higher returns. By selling and exchanging land into other types of real estate such as office buildings or apartment complexes, a family may be able to substantially increase their annual cash flow.
Use of a 1031 exchange can also eliminate active management of the investment. Exchanging farm and ranch land into other passive real estate investments or into properties that are professionally managed, may enable a family to free themselves of the day-to-day activities of running their farm or ranch. Ironically, an agricultural family can often sell their place and increase their income without having to work nearly as hard for it.
Wealth can also be built using a 1031 exchange. Investing money that would have gone to taxes in other real estate may allow you to accumulate more wealth over time.
Consider the following example: A Wyoming couple sells land that is owned in joint tenancy for $5 million with a cost basis of $500,000. If the couple were to cash out, they would owe capital gain tax of approximately $900,000.
If this same couple were to do a 1031 exchange on the full $5 million sale, this $900,000 could be invested in additional real estate. Assuming the real estate grew at an average annual compound rate of seven percent, which represents income plus appreciation, in 20 years this $900,000 would be worth approximately $3.6 million.
Under current tax law, heirs of a descendant’s property receive a “step-up” in basis of the property’s tax basis to its fair market value upon death. This step-up in basis could conceivably enable the heirs to inherit property and then sell the property for fair market value soon after the decedent’s death and pay little or no tax.
Thus, holding the appreciated real estate until death, the family could not only defer taxes on the sale of property but permanently eliminate them.
IRC Section 664 Charitable Remainder Trust
A Charitable Remainder Trust (CRT) is another powerful tool to bypass taxes on the sale of appreciated real estate. A CRT can also be used to avoid tax on the sale of other ranch assets such as livestock, crops, machinery and equipment.
A CRT provides many potential benefits for a ranch family, including those listed below:
Saves tax on the sale of appreciated land and on the sale of livestock, crops, machinery and equipment;
Generates an immediate charitable income tax deduction that can be used to offset income tax;
The full sales proceeds, undiluted by tax, can be invested to generate income for the remainder of the donor(s) lives;
Provides a vehicle to diversify assets for retirement income;
May reduce or avoid estate taxes;
Supports one’s favorite church and/or charities;
Provides a lasting legacy for the donors.
Using a combination of a 1031 exchange, charitable remainder trust and a direct sale for cash can often be an optimal strategy for reducing income and estate taxes and providing diversification of investment assets.
IRC Section 121 Personal Residence Exclusion
A personal residence is typically involved with the sale of a ranch. The IRC Section 121 Personal Residence Exclusion allows an individual to exclude up to $250,000 of taxable gain from the sale of a principal residence and a married couple filing a joint return to exclude up to $500,000 of gain.
To help maximize the amount of tax-free cash you may receive from the sale of a farm or ranch containing a personal residence, it may be possible to include additional acreage with the home.
There can be significant tax consequences to selling a ranch. Financial tools can be used to save taxes, which can help you generate more income for retirement and pass more wealth to your children and grandchildren. To utilize these tax saving tools, one must engage in planning prior to the sale.
There are complex rules and strict time parameters for completing a successful 1031 exchange or Charitable Remainder Trust.
Chris Nolt is the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, Inc., sister companies dedicated to working with families throughout the country who are selling a farm or ranch and transitioning into retirement.
For more information on these tax saving tools and other planning strategies for selling a farm or ranch, request a free Wealth Guide by calling 406-582-1264. For more information, visit solidrockwealth.com and solidrockproperty.com.