The Basics of a 1031 Tax Exchange
One of the most frequently asked questions from farmers is - “Can I avoid taxes when selling my poultry farm?” My answer is always the same - “You can defer the tax on the sale and most of the time it makes financial sense.” We asked our friends at First American Exchange Company to break down the process for us.
The process can be broken down into six parts.
1. Scope of the 1031 exchange
Selling a poultry farm, like selling any business, often involves real estate and equipment. Farm owners interested in exchanging a poultry farm in a tax-deferred exchange under Internal Revenue Code §1031 need to focus on the particular property being bought or sold in order to maximize the amount of gain that they will be able to defer.
2. Exchangeable Assets
The first and most important step when exchanging a poultry farm is to itemize the various assets and determine which of those assets are exchangeable. Since the passage of the Tax Cuts and Jobs Act of 2017, only real property can be exchanged under Internal Revenue Code §1031. The IRS defines real estate as “Real property, also called real estate, is land and generally anything built on or attached to it.” A tractor is not real estate. Other assets such as personal property, goodwill, and inventory are not exchangeable. It’s important to work with a tax advisor to determine the portion of the sale price allocated to the real property being sold, which is the amount on which the exchange can be completed. In order to accomplish a fully tax-deferred exchange on the real property, you will need to acquire like-kind real property of an equal or greater value and use all of the real property cash proceeds for the purchase.
3. Exchanging Real Property Assets
Real Estate and Buildings: The real estate assets of a poultry farm include the land and any improvements attached to the land, such as a house or a barn. If a house on the farm is occupied by a tenant, worker, or caretaker on the property, it is considered investment property or property used in a trade or business and is exchangeable under §1031. On the other hand, if the owner lives in a house on the property and it is considered the owner’s primary residence, there are advantageous tax strategies that can be implemented in conjunction with the 1031 exchange. When a property is held partially for personal use and partially for investment, such as a poultry farm with an owner-occupied home, a portion of the gain from the sale of the personal residence is exempt from tax under IRC §121 (provided the owner has lived there for two out of the five years preceding the sale), and the remaining tax can be deferred under §1031. Revenue Procedure 2005-14 clarifies how Sections 121 and 1031 can be used at the same time in connection with the disposition of the same property.
4. Like-kind property
Per §1031(a)(1), the properties on both sides of the exchange must be "held for productive use in a trade or business or for investment.” Further, §1031 allows for the deferral of capital gain tax if such property is exchanged solely for property of "like kind." Contrary to what many people believe, "like kind" does not mean that an investor must, for example, exchange land for land, or a duplex for a duplex. In the context of real estate, like-kind exchanges are valid between and among several different types of investment property, including raw land, commercial property, industrial buildings, retail stores, apartments, duplexes--even leasehold interests exceeding 30 years and certain oil and gas interests. The liberal definition of "like kind” in real property exchanges means significant advantages for the investor who elects to perform a 1031 exchange. For example, when raw land is traded for a small retail center, capital gain taxes can be avoided, and the investor will also reap the benefits of owning a property that will generate increased cash flow. Another advantage in this example is that depreciation can be taken on the retail center, an option that was not available when the investor held raw land.
When identifying replacement property, you may identify up to three replacement properties no matter what their value (the “three property rule”), or if more than three are identified, the total fair market value of the property identified cannot be greater than twice the total fair market value of the property sold (the “200% rule”). Identification must be in writing and should include a complete address or legal description. If you are acquiring less than 100% of a property as a tenant in common interest, you must indicate the percentage being acquired on the identification form. The purchase of identified property must be completed by the earlier of (1) 180 days from the sale of the relinquished property, or (2) the due date for filing the tax return for the year in which the relinquished property was sold. However, you can file an extension for filing the tax return in order to take advantage of the full 180-day exchange period.
The sale of a poultry farm typically involves several asset types. It is important for an investor to analyze the types of property being sold and pre-plan their exchange by consulting with a tax advisor to maximize their tax deferral. The professionals at First American Exchange are available to assist you with the tax-deferral process. References: Revenue Procedure 2005-14. IRC §1231(b)(4).
Chief Executive Officer, Broker
While other brokerages divide their time offering a variety of property types for sale, American Poultry focuses all of its resources on the sale of poultry farms. Our focus allows American Poultry to out-market and out-perform our competitors. American Poultry Company worked their way to the top, as an industry leader, by taking a very different approach to brokerage. They devote all of their team’s energy behind a singular task, brokering poultry farms between buyers and sellers.