By: Gary J. Heim, Esq.
Most farmers and land owners have heard of a like-kind exchange, which goes by several other names, including a 1031 exchange or a tax-free exchange. The primary purpose of an exchange is to reduce the federal income taxes resulting from the sale of real estate.
Although an exchange will not be appropriate in all situations, it should be considered whenever business, farm or investment real estate is being sold. Projecting the income taxes payable from the sale if an exchange is not used is the starting point. To qualify for the tax savings, not only must the real estate being sold (relinquished property) be used for farm, business or investment purposes, but also the real estate that is being purchased (replacement property) must be held for farm, business or investment purposes. It is not an all or nothing requirement, however. The seller can keep some of the cash from the sale and only invest a portion of the sale proceeds in other real estate, but the income tax savings will only apply to the portion of the proceeds reinvested in qualified real estate.
Farm real estate can be exchanged for an apartment or other commercial property; the replacement property does not have to be a farm. The like-kind requirement is satisfied as long as real estate is exchanged for real estate (used for farm, business or investment purposes).
Some of the more common situations where our office has assisted PFB members with exchanges include: (1) the sale of agricultural conservation easements; (2) the relocation of a farm operation from one place to another; (3) the sale of a portion of the farm for warehousing or other development purposes; (4) rearranging the ownership of jointly-owned property among siblings or others; and (5) the condemnation of property for highway, school, pipeline or other purposes (there are more lenient IRS rules for reinvestment of condemnation proceeds).
The like-kind exchange process usually involves four advisors or services, including: (1) a tax preparer/advisor; (2) an attorney to prepare the agreements of sale and related documents; (3) a title insurance company to insure title to the property; and (4) a qualified intermediary (QI). The QI is used to satisfy the IRS condition that the seller cannot actually receive the sale proceeds. Instead, the QI receives and holds those proceeds until it is directed to release the money to purchase a replacement property.
The IRS has rigid deadlines that cannot be extended for hardship or other reasons in the like-kind exchange process. For example, replacement properties need to be identified within 45 days of the closing for the relinquished property. Similarly, the closing for the replacement property needs to take place within 180 days of the closing for the relinquished property.
The attorneys at Mette, Evans & Woodside have guided and assisted many PFB members through the like-kind exchange process and can assist you in the evaluation and implementation of a like-kind exchange.