Selling farmland is a process that requires landowners to navigate preparing, valuing, and listing their property. Their personal connection to the land, the complexity of the assets included in the sale, and the sheer size of the transaction all make proper knowledge and planning vital. One of the most important obstacles farmers must understand when selling farmland is capital gains tax.
With that in mind, what are capital gains taxes, and what can you do to reduce their impact?
What Are Capital Gains Taxes?
Capital gains taxes are applied to the profit from the sale of property—essentially, the difference between how much you paid for it and for how much it sold. Once the sale is complete, any profit is considered a “realized net capital gain” for that year.
To determine how, or if, capital gains taxes apply to you, you need to understand how the money you made on the sale would be classified. This requires a brief introduction to the two types of capital gains: short-term and long-term.
Short-Term Capital Gains
Short-term capital gains are gains realized on assets owned for under a year. This rarely applies to farmland, but there are some exceptions. For example, you may have received your farmland as an inheritance or gift from a relative. In that case, proceeds from the sale will likely be taxed as ordinary income. You would be paying federal and state income tax on the money, but not capital gains tax.
Long-Term Capital Gains
Long-term capital gains are gains realized on assets owned for a year or longer. If you are selling your farmland for a profit, you can owe up to 20 percent. This depends, however, on several factors, including your income.
This is the type of gain that applies to most farmland sales (aside from the exceptions above). Long-term gains are taxed using the capital gains tax rate, not ordinary income tax rates.
Minimizing the Capital Gains Tax Burden of Selling Farmland
If you are hoping to retire—or simply move on from farming—after selling your farmland, capital gains taxes can present an obstacle. However, you do have options. There are three primary tactics farmers use to reduce the capital gains tax burden: 121 principal exclusions, 1031 exchanges, and charitable remainder trusts. These strategies are introduced below and explored in more detail in our guide to farmland tax considerations. Selling Farmland: Tax Considerations.
Tactics for Reducing Capital Gains Taxes on Farmland
121 Principal Exclusion
A 121 principal exclusion offers advantages for farmers who reside primarily on the land they are selling. This strategy allows those selling their primary residence to exclude carrying amounts ($250k for individuals, $500k for people filing jointly) of the appreciation from their taxable income. Essentially, if you reside in a home on your property, you may qualify for a 121 principal exclusion after selling it.
However, you’ll need to meet several conditions to obtain a 121 principal exclusion. To qualify for one, you must have:
- Owned and lived in your home for at least two of the past five years
- Not used this exclusion in the past two years (If you sell two houses in two years, we recommend excluding the highest-valued property.)
- Not received your home as part of a section 1031 exchange
1031 Exchange
If you are trying to sell farmland but are planning to continue farming after the sale, a 1031 exchange is a valuable option. Also known as a “like-kind” transaction, this allows you to trade your property for a similarly valued asset without reporting it as a gain or loss.
Section 1031 exchanges must be completed within 180 days, and you’ll need to submit an “unambiguous description” of any possible replacement properties within the first 45 days.
If you decide to purchase multiple properties, they must follow certain guidelines. You can:
- Identify 1‒3 properties of any value if you intend to purchase at least one.
- Identify more than 3 properties valued at no more than 200 percent of the market value total of the property you are selling.
- Identify more than 3 properties valued at more than 200 percent of the market value total of the property you’re selling, with the understanding that you must acquire at least 95 percent of the market value of all properties.
664 Charitable Remainder Trust
A charitable remainder trust, or CRT, is a trust that one can transfer assets into to generate an income stream for themselves or another beneficiary for a set term (or for the remainder of their life) with any remaining assets being given to a named charity. If a property is transferred to a CRT, it will be exempt from capital gains taxes, and all funds from the sale will remain in the trust and pay out in the form of an annuity based on the terms set when the trust is created.
Special Deal Structures
Since capital gains taxes are applied based on the proceeds from sales, special deal structures that can be leveraged to defer or reduce the tax burden. One option that we see often at Fall Line Capital is “owner financing”. Here, the seller allows the buyer to pay for the property over time, essentially offering them a loan.
In this structure, the buyer will pay for the property over time, allowing the capital gains tax burden to be spread across several years as opposed to being applied all at once. If you are considering this option, you should work with an experienced buyer who has the long-term capacity to support this agreement.
Developing a Farmland Sale Strategy with Fall Line Capital
We want our land purchases to be mutually beneficial, and we have the flexibility and expertise to help sellers reduce their tax burden. Most importantly, we provide security in knowing that the land will continue to be cared for and preserved for future generations. Land stewardship begins—and ends—with careful planning. Contact us today at info@fall-line-cap.com or 1-650-235-4032. We look forward to working with you.