Thinking about selling your farmland? Whatever the reason, selling your farmland comes with a lot of planning, from preparing to valuing, listing your property, and capital gains taxes at the top. Yes, capital gains taxes- the reason so many farm owners are hesitating to sell their farmlands Want to discover how to avoid capital gains tax when selling your farmland? Read along
What Are Capital Gains Taxes?
Capital gains taxes are taxes mandatory on the profit from the sale of a property. It is the difference between how much you pay for the property and how much it is sold for. Once the property is sold, any profit is considered a realized net capital gain for the year.
To determine if capital gains taxes apply to you, you need to understand how the money made on the sale of your farmland would be classified.
Property sold can be classified as short-term or long-term capital gains.
Short-term capital gains are gains realized on assets you’ve owned for less than a year. While this rarely applies to farmlands, there are some exceptions. For example, if you inherited your farmland or received it as a gift from a relative, the proceeds from the sale could be taxed as ordinary income. This means you would pay federal and state income tax on the proceeds of the property sale but not capital gains tax.
Long-term capital gains, on the other hand, are gains realized on assets owned for a year or more. If you sell your farmland for profit, you could owe up to 20 percent of capital gains tax, depending on several factors, such as your income. Long-term capital gains are applicable to most farmland sales.
How To Avoid Capital Gains Tax When Selling Farmland
If you’re hoping to move on from farming and have decided to sell your farmland, you’ll need to find a way to minimize the capital gains tax burden you might face. Here are some IRS-approved tricks to avoid capital gains tax when selling your farmland.
121 Principal Exclusion
A 121 principal exclusion offers a great advantage if you live primarily on the farmland you sell. This typically means you’re also selling your primary residence. This strategy allows those selling their residence to exclude carrying amounts ($250 for individuals and $500 for couples filing jointly) of the appreciation from their taxable income. If you live in a home on your farm, you could qualify for a 121 principal exclusion after selling it.
However, you must meet the following conditions to qualify for a 121 principal exclusion:
- Owned and lived in your home for at least two out of the past five years
- Not used the 121 principle exclusion in the past two years
- Not received your home as part of a section 1031 exchange
1031 Exchange
If you want to sell your farmland but plan to continue farming after selling, a 1031 exchange might be a great option. The 1031 exchange allows you to trade your property for a similar valued asset without reporting it as a loss or gain.
However, the Section 1031 exchanges must be completed within 180 days. In the first 45 days, you’ll also need to submit an “unambiguous description” of possible replacement properties.
If you choose to buy multiple properties, you must follow specific guidelines which are:
- Identify 1-3 properties of any value if you intend to purchase at least one.
- Identify more than three properties with not more than 200 percent of the market value total of the property you are selling.
- Identify more than three properties valued at over 200 percent of the market value of the property you are selling while acquiring at least 95 percent of the market value of all properties.
664 Charitable Remainder Trust
A charitable remainder trust is a trust you can transfer assets into to generate an income stream for yourself or other beneficiaries for a specific time or the remainder of your life, with the remaining asset given to a preferred charity. If your property is transferred to a charitable remainder trust, it will be exempt from capital gains taxes, funds from the sale will also remain in the trust, and payouts will be made in an annuity based on set terms set when the trust is created.
Deferred Sales Trust
A deferred sales trust is a reliable way to defer your capital gains taxes on your farmland. A DST allows you to sell your property to the trust, then sell it to a buyer, and keep the proceeds. As a result, the trust then issues you a promissory note. This means you have yet to receive the proceeds from the sale directly. Therefore, your capital gains remain deferred. With a DST, you could structure the trust to reinvest into profitable investment options, giving you flexibility in timing and allowing you to diversify your investments.
Take Home
While there are many options to help you avoid capital gains tax when selling your farmland, choosing the best option for you can be confusing. Working with an experienced tax expert like Tax Goddess not only provides the most tax-favorable option for selling your farmland but also helps you make the most of your tax opportunities.
Ready to tap into a new world of tax-saving strategies? Book a free consultation with the Tax Goddess Team today!
