1031 Exchanges for Agricultural Properties

The basic process of a 1031 exchange is the taxpayer sells their relinquished property, the money from the sale is transferred directly to the qualified intermediary (QI) to hold on behalf of the taxpayer, then the taxpayer purchases a replacement property or properties using the money held by the QI. It is important that the QI is contacted prior to the closing on the relinquished property and involved in the whole process, because if any money from the closing goes to the taxpayer, it can no longer be used in the exchange and the taxpayer will be taxed on it. There are other types of exchanges such as a reverse exchange or improvement exchange that deviate from this. 

There are two deadlines when dealing with a 1031 exchange: a 45-day identification period and a 180-day period to purchase any replacement property. Both deadlines begin on the date that the relinquished property is sold and run concurrently. For the first deadline, occurring at 45 days, the taxpayer must identify any potential replacement properties that they may want to purchase. There is a limit on the number of properties that can be identified. The second deadline, occurring at 180 days, is the last possible day to acquire any of the identified replacement properties.  There is very little flexibility with the deadlines, with exceptions made for Federally declared disasters and terroristic and military actions.

In order for property qualify for an exchange, it should be held for productive use in a trade or business or investment. The IRS will look towards purpose and intent in holding the property when determining if it qualifies. Types of properties that qualify include residential, commercial, industrial, or retail rental properties, business offices, farmland, oil/gas/mineral rights, and Delaware statutory trusts (DSTs). Properties that would not qualify for a 1031 exchange include primary residences, properties held primarily for sale (“flip” houses), personal-use vacation homes, and partnership interest in real estate. When exchanging properties, they do not need to be the same type of property to qualify for the exchange, they just both have to be qualified properties.  or example, the taxpayer could sell a rental house and purchase farmland. 

In order to obtain the maximum tax benefit from an exchange, the replacement property must be greater in value and equity than the relinquished property. This means that the taxpayer must purchase property that is worth more than the property they sold, and they have to use all of the money from the sale of the relinquished property towards the purchase of replacement property.

It is possible to have a portion of the money from the sale of the relinquished property go to the taxpayer for personal use rather than have it all go to the qualified intermediary for the purchase of the replacement property. This does not reduce the value of the real estate that needs to be purchased for the exchange! If the taxpayer sells property for $250,000 and takes out $50,000 in cash, their replacement property will still need to be $250,000 in value. The taxpayer will be responsible for paying the capital gains tax on the amount they pull out of the exchange, so it is important that they consult with their tax advisor to make sure that they will still be benefiting from the 1031 exchange.