The Power of a 1031 Exchange for Those Retiring from Farming or Ranching
A 1031 Exchange is commonly used with the sale of a farm or ranch because there is often a large taxable gain on the land being sold. The 1031 Exchange allows the landowner to defer taxes on the gain by investing in other property.
In this article, I will discuss why a person should consider a 1031 Exchange.
Many farm and ranch owners often think only of the initial tax-savings they can realize by using a 1031 Exchange, ignoring the future wealth building potential of using a 1031 Exchange. Saving taxes with a 1031 Exchange allows producers to purchase more real estate. This enables them to accumulate greater wealth.
For example, if someone sells $1 million worth of land with a cost basis of $100,000, they will likely save between $180,000 to $260,000 in taxes by performing a 1031 Exchange.
If they saved $200,000 on taxes and they earn a seven percent cash flow return on an income producing replacement property, they would generate an additional $140,000 per year of income by performing a 1031 Exchange.
If someone lived for 20 years, the income and appreciation from this additional real estate could amount to a small fortune.
Stepped-up cost basis
Taxes are deferred with a 1031 Exchange until they later sell the property in a taxable transaction. However, if a homeowner held real estate until they die, their heirs receive a “stepped-up” basis to the fair market value of the property when they die.
This means it’s possible to not only defer tax on the sale of appreciated property but to avoid the income tax altogether.
Farm and ranch owners who are downsizing or transitioning into retirement typically use the 1031 Exchange to acquire residential or commercial property that will generate income for them to live on. They usually do this because they can generate a higher cash flow return on these types of properties.
In my experience, land usually generates a cas hflow return of one to two percent while other types of income producing investment properties generate returns in the five to eight percent range. And, while an investor cannot depreciate the cost of land over time, homeowners/landowners can depreciate the cost of buildings which can reduce tax consequences on the income the buildings generate.
In summary, farm and ranch owners who plan on selling their property and retiring should explore the financial benefits associated with a 1031 Exchange.
Chris Nolt is an independent, fee-only registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement. To order a copy of Chris’s new book “Financial Strategies for Selling a Farm or Ranch,” visit Amazon.com or call Chris at 800-517-1031. For more information, visit solidrockproperty.com or solidrockwealth.com.