Updated: Sep 16, 2019
Section 1031 allows farmers to defer capital gains on the sale of a farm if it is exchanged for similar or "like-kind" investments. In a 1031 exchange a poultry farm is sold, the money is held by a title company or attorney, and the money is used to purchase another property to replace the one that has been sold. To most people, the transaction looks like a farm was sold and the proceeds went to purchase an investment, but to the IRS it was "exchanged" because no profit was personally taken by the seller.
The sale of real estate and equipment with high cash value but low to zero cost basis creates opportunity for tax deferral. Like-kind real property exchanges have lots of flexibility when determining what is like-kind. Examples that are interchangeable include: farms, apartments, retail buildings, and residential property, to name a few!
A 1031 exchange can be really powerful. If you have a $2,000,000 farm sale that has been depreciated down to $500,000, you could sell it and pay the taxes on the $1,500,000 gain, or you could exchange it and put the whole $2,000,000 back to work.
Note: If you want to defer all of the capital gains tax, you must reinvest ALL of the proceeds. Every dollar of gain you don’t reinvest is a dollar of gain you pay tax on now! It is the choice of the farmer how much to reinvest and how much to keep and pay taxes on the receipt.
Once you have taken possession of the proceeds personally, you can not do an exchange. Once a farm is listed for sale the owner or broker needs to start looking for the replacement property to exchange. When a contract is taken on the farm the owner gets the 1031 paperwork in order and informs the closing attorney of the intention to exchange. During the closing, the attorney will write the check to the 1031 company to hold until the replacement property has been found and will purchase the new property with the funds from the closing. Typically a seller with have 45 days to identify the new property to purchase and 180 days to complete the 1031 exchange. Many times the seller will use the proceeds (2 million) as down money on a larger investment and borrow the remainder for a bank. Given a typical bank 2 million down can purchase a 10 million dollar investment property.
Many rules and regulations drive the exchange process and it is important to choice a 1031 company that has a good reputation and proven track record. Many times the 1031 company will work closely with your CPA during the process to insure the transaction goes as planned with no triggering of additional taxes.
***No warranty is made with the above statements as tax rules are subject to change, consult a CPA or 1031 exchange company for rules and regulations governing transactions. ***