FAQ

IRC Section 121 allows an individual to exclude up to $250,000 of taxable gain from the sale of a principal residence and a married couple filing a joint return to exclude up to $500,000 of gain.  This exclusion can only be used in conjunction with real property that has been held and used as the homeowner’s primary residence. It does not apply to second homes, vacation homes, or property that has been held for rental, investment or use in a trade or business.

Homeowners are required to have owned and lived in the home as their primary residence for at least a combined total of 24 months out of the last 60 months (two out of the last five years) in order to qualify for the Principal Residence Exclusion.  The 24 months does not have to be consecutive.

If you’re home is included in the sale of your farm or ranch, it may be wise to assign as much value as legally possible to the home so you can maximize the amount of tax-free proceeds from the sale. It is possible to include additional acreage around the home when determining a value for the home as long as the acreage does not include other buildings used for business purposes. Make sure to discuss this strategy with your real estate agent and CPA.

Often times the home a family is residing in on the farm or ranch is owned by the same entity that owns the other ranch property. A home owned by an entity is not eligible for the Principal Residence Exclusion.

The sale of ranch property may or may not be subject to the 3.8% surtax on Net Investment Income. The rules and methods for computing this tax are complex and beyond the scope of this book. If you are considering selling property, make sure to seek the guidance of your CPA in determining if you will have to pay this tax.

There are other exceptions, but generally whether or not you will be subject to the 3.8% tax on Net Investment Income depends on whether the gain is attributable to an active business of the entity and whether the taxpayer materially participates in that business.

Generally, a passive activity is one in which the taxpayer does not “materially participate”. IRC section 469 (h)(1) defines “material participation” as involvement in the operation of the activity on a regular, continuous, and substantial basis.

Here are a couple of examples of situations where the taxpayer would be subject to the 3.8% tax on net investment income.

Example 1:

If two siblings own a farm, and one runs it and the other is a passive investor.  The sibling actively working on the property will generally not be subject to the tax on sale of the farm, but the gain on the sale realized by the passive sibling would (to the extent he and his spouse’s income exceeds $250,000).

Example 2:

If you own property but lease the property out, you will likely be subject to the tax.

The good news is, the 3.8% tax on Net Investment Income can be deferred by selling the property through a 1031 exchange or CRT.

Consult your tax advisor for specifics regarding your personal situation.

The Health Care and Education Reconciliation Act of 2010 added a new 3.8% Medicare Surtax on “net investment income.” This 3.8% Medicare surtax applies to taxpayers with “net investment income” who exceed threshold income amounts of $200,000 for single filers and $250,000 for married couples filing jointly. Pursuant to IRC Section 1411, “net investment income” includes interest, dividends, capital gains, retirement income and income from partnerships (as well as other forms of “unearned income”).

Below Is A Summary Of The Five Ways Investors May Be Taxed On The Sale Of A Farm Or Ranch:

1. Federal Ordinary Income Tax: Taxpayers will be taxed at rates up to 39.6% depending on taxable income.
2. Federal Capital Gain Taxes: Investors owe Federal capital gain taxes on the their economic gain depending upon their taxable income. Since a new higher capital gain tax rate of 20% has been added to the tax code, investors exceeding the $400,000 taxable income threshold for single filers and married couples filing jointly with over $450,000 in taxable income will be subject to the new higher tax rate. The previous Federal capital gain tax rate of 15% remains for investors below these threshold income amounts.
3. State Taxes: Taxpayers must also take into account the applicable state tax, if any, to determine their total tax owed. Some states have no state taxes at all, while other states, like California, have a 13.3% top tax rate. Montana currently has a top rate of 6.9%.
4. Depreciation Recapture: Depreciation recapture is the IRS procedure for collecting income tax on a gain realized by a taxpayer when they dispose of an asset that had previously provided an offset to ordinary income for the taxpayer through depreciation. Taxpayers will be taxed at a rate of 25% on all depreciation recapture.

New Medicare Surtax Pursuant to IRC Section 1411: The Health Care and Education Reconciliation Act of 2010 added a new 3.8% Medicare Surtax on “net investment income.” This 3.8% Medicare surtax applies to taxpayers with “net investment income” who exceed threshold income amounts of $200,000 for single filers and $250,000 for married couples filing jointly. Pursuant to IRC Section 1411, “net investment income” includes interest, dividends, capital gains, retirement income and income from partnerships (as well as other forms of “unearned income”).

Federal capital gain tax rates vary depending on the marginal income tax bracket that you fall in. In 2016 they are as follows:

0% if you are in the 10% or 15% brackets
15% if you are in the 25%, 28%, 33% or 35% brackets
20% if you are in the 39.6% bracket

What are the 2016 federal capital gain tax rates?

2016 Federal Capital Gain Tax Rates

The 3.8% Medicare surtax only applies to “net investment income” as defined in IRC §1411.

Various tax rates and tax treatment apply to the different types of assets involved with the sale of a farm or ranch. It is imperative that you and seek direction from your tax advisors when purchase price allocation is being negotiated.

Allocation of sales price
How you allocate the sales price to the assets of your ranch will determine the tax you may ultimately pay. Conflict can arise when negotiating how to allocate the sale price. You, the seller, want to pay tax at the capital gain rate because it is currently lower than ordinary income tax rates. Conversely, the buyer wants to allocate more of the sale price to depreciable assets.

When a farm or ranch is purchased or sold, both the buyer and seller must report to the IRS the allocation of sales price. IRS form 8594 is titled the Asset Acquisition Statement. This form should also be attached to the buyer and seller’s federal income tax return for the year of the sale.

Below is a list of asset categories and the type of tax owed on each category:

Inventory and Supplies: Crops, fertilizer, etc.

• Taxed at ordinary income rates

Livestock

• Raised livestock – breeding stock
  • Cattle and horses – held greater than two years – taxed at capital gain rates
  • Other livestock – held greater than one year – taxed at capital gain rates
  • There is no cost basis in raised livestock

• Purchased livestock – Breeding stock
  • Cattle and horses – held greater than 2 years – taxed at capital gain rates
  • Other livestock – held greater than 1 year – taxed at capital gain rates
  • Cost basis is purchase price. Depreciation recapture rules apply

• Purchased or raised livestock that is held for sale
  • Taxed at ordinary income rates

Equipment

• Irrigation systems, swathers, bailers, tractors, etc. IRC Section 1245 assets. Recapture of depreciation applies.

Ranch House

• IRC Section 121 Exclusion:
  • Gain does not apply to extent of any depreciation claimed after 5/6/97. IRC Section 121 (d) (6).
  • No allocation of exclusion is required if both the residential and business portions of the property are with the same dwelling unit, other than to the extent the gain is attributable to depreciation after 5/6/97.
  • 121 Exclusion is not eligible for homes owned in a corporation.

Buildings

• Single-Use Property – IRC Section 1245 depreciation recapture applies.
• IRC Section 1250 Property – potential depreciation recapture may apply.

Land

• Gain taxed at capital gain rates

It is best to start planning for the sale of your farm or ranch well in advance of a sale. Many farm and ranch owners make the mistake of waiting to plan until they have an interested buyer or a signed contract.
If you wish to do a 1031 exchange for some of your sale, you only have 45 days from the closing of your relinquished property to identify your replacement property(s). It takes time to identify and perform due diligence on investment property. It is wise to research potential replacement properties well in advance of a sale so you aren’t scrambling to locate properties at the last minute. Ideally, you want to close on your replacement property as soon as possible after the closing of your relinquished property.

If you are considering using a charitable remainder trust for part of your sale, it is also very important to plan ahead of time. In fact, if you have a signed buy-sell agreement on your farm or ranch property, you can no longer utilize a charitable remainder trust on the sale.

You can save tax on the sale of a farm or ranch by using either the IRC Section 1031 Exchange or the IRC Section 664 Charitable Remainder Trust. A combination of these can be used for a sale.

No. A REIT is a corporation that purchases, owns and manages real estate properties and/or real estate loans. You can purchase shares in a REIT much like a mutual fund. You cannot do a 1031 exchange into shares of a REIT because the shares of a REIT are considered personal property even though the REIT, at the entity level, owns real property assets.

An UPREIT (Umbrella Partnership Real Estate Investment Trust) is an alternative to a section 1031 like-kind exchange. Instead of selling the property, the owner contributes it to an UPREIT in exchange for securities called “operating partnership units” or “limited partnership units.” Unlike selling the property, this transaction doesn’t create a taxable event.

UREITs are complex investments. If you want to defer tax on the sale of appreciated real estate, I suggest you use the 1031 exchange and stick to investing in fee-simple real property that you own and control.

Some examples of property that do not qualify for a 1031 exchange are:

• Property you use for personal purposes, such as your home and your family car.
• Stock in trade or other property held primarily for sale, such as inventories, raw materials and real estate held by dealers.
• Stocks, bonds, notes or other securities or evidences of indebtedness, such as accounts receivable.
• Partnership interests.
• Certificates of trust or beneficial interest.

You must identify the property to be received within 45 days after the date you close of the sale of your relinquished property. There are three property identification rules:

Three Property Rule: You may identify up to three replacement properties of any value.
200% Rule: You may identify any number of properties as long as the aggregate fair market value of the replacement properties does not exceed 200% of the aggregate FMV of all of the exchanged properties as of the initial transfer date.
95% Rule: You may identify any number of replacement properties if the fair market value of the properties actually received by the end of the exchange period is at least 95% of the aggregate FMV of all the potential replacement properties identified.
Like-Kind Property

In a like-kind exchange, both the property you sell and the property you purchase must be held by you for investment or for productive use in your trade or business. Properties are of like-kind if they are of the same nature or character. This definition is very broad. One may exchange land for office buildings, apartment complexes, retail stores, warehouses etc.

You must identify your 1031 exchange replacement property within 45 days of closing on your relinquished (sold) property. You have a total of 180 days from the closing of your relinquished property to close on your replacement property.

The term “boot” refers to any property received in an exchange that is not considered “like-kind.” Cash boot refers to the receipt of cash. Mortgage boot (also called “debt relief”) is a a term describing an exchanger’s reduction in mortgage liabilities on a replacement property. Any personal property received is also considered boot in a real property exchange transaction.

A taxpayer must not receive “boot” from an exchange in order for the exchange to be completely tax deferred. Any boot received from the exchange is taxable to the extent of gain realized on the exchange.

Boot received can result from a variety of factors. Two of the most common result from “trading down” in a 1031 exchange. Trading down occurs when the replacement property is not of equal or greater value than the relinquished property. For example, if a taxpayer takes cash out of the exchange, or does not acquire a comparable amount of debt on his replacement property as he had on his relinquished property, he will end up trading down because there is not enough cash and/or debt to purchase a replacement property of value equal to his relinquished property.

In summary, if a taxpayer wishes to fully defer tax on an exchange, they must meet two requirments:
1. Reinvest the entire net proceeds in one or more replacement properties. 2. Acquire one or more replacement properties with the same or greater amount of debt. An exception to this requirement is that a taxpayer performing an exchange can offset a reduction in debt by adding cash to the replacement property at closing.

A good way to remember this is to understand that for a taxpayer to defer 100% of the tax in an exchange, they must “trade up or stay equal in debt and equity”.

No, your home is considered personal property and does not qualify for a tax-deferred exchange. However, subject to certain limitations, your home may qualify for the IRC Section 121 Principal Residence Exclusion.

Owning appreciated real estate in a partnership or other entity can present challenges if there are multiple partners, members or shareholders with different goals upon sale. Because partnership interests do not qualify for a 1031 exchange, the individual partners are not able to do their own 1031 exchange.

The IRC 1031 exchange provisions require that the entity selling the relinquished property must be the same entity taking title to the replacement property. So in this case, the partnership would have to perform the exchange and each partner could not do his or her own exchange. Fortunately, there are solutions to this problem.

Solution 1: Drop And Swap
Prior to a sale, the partnership could distribute (drop) the property out of the partnership. Each partner would take title to their ownership in the property as tenants-in-common. This would allow each partner to then perform a 1031 exchange (swap) for their ownership in the property if they so desired. To comply with IRS rules, it is important that the distribution of the property out of the partnership take place well in advance of a sale.

Solution 2: Swap And Drop
Using this strategy, the partners could each identify their own separate property (ies) they wish to own. The partnership would perform the exchange (swap) and at a later date, preferably longer than one year, the partnership could distribute the property (drop) to each partner “in-kind”. Once again, consult your CPA and/or attorney regarding the use of this strategy.

Please consult your CPA and/or attorney regarding this matter.

For information on planning for the sale of property owned in an a partnership, see our Wealth Guide, What You Need To Know When Selling A Farm Or Ranch.

Yes, corporations can perform a 1031 exchange. However, using a 1031 exchange with property owned in a corporation can be complex. Make sure to consult your tax advisor if you are considering a 1031 exchange

For information on using the 1031 exchange with property owned in corporations, see our Wealth Guide, What You Need To Know When Selling A Farm Or Ranch.

Yes, personal property can qualify for a 1031 exchange but the “like-kind” requirements are much stricter than they are for real property. For example, cows must be exchanged for cows, bulls for bulls, a tractor for a tractor etc. A potentially better solution for bypassing taxes on the sale of livestock, crops, machinery and equipment is to use a Charitable Remainder Trust for the sale of those assets.

Although it is important to look to the treatment of easements under the applicable state laws, in many cases an easement is considered like-kind to any other like-kind real property held for productive use in a trade or business or for investment.

The following are qualified exchanges:

• An agricultural conservation easement in perpetuity in a farm found to be real property, for a fee simple interest in real property.
• An exchange of agricultural easements over two farms for fee-simple title in a different farm.
• A perpetual conservation easement encumbering real property for the fee simple interest in either farm land, ranch land, or commercial real property.
• A scenic conservation easement, found to be real property under state law, for a fee simple interest in timber, farm land, or ranch land.

Yes, water, timber and mineral rights may also be eligible for exchange. In many states, water rights are treated as real property interests. In those states where water rights are classified as real property interests, the conveyance or long term leasing of water rights could be utilized for the purposes of effecting a 1031 exchange into other “like kind” investment property.

With regard to timber rights, there have been an increasing number of farmers and ranchers who own timber property and entered into timber sale contracts with various logging companies. They have attempted to use those sale proceeds to acquire properties in a Section 1031 exchange. Unfortunately, the Internal Revenue Service has relied upon a 1953 tax court case, known as the Oregon Lumber Company Case, in disallowing those transactions as exchanges.

Timber rights, however, much like water rights or mineral rights, are classified as real property interests in many states. Properly structured, the conveyance of timber rights should be the basis for an exchange into other “like kind” property.

An exchange of real estate for mineral rights is permitted if the mineral rights relinquished or acquired in an exchange constitute an interest in real property that is “like-kind” to a fee interest in real estate under federal tax law. The determination of whether a mineral right will be considered like-kind to a fee interest in real estate depends on: the specific nature of the rights granted under the mineral contract, the duration of those rights, and whether the law of the State in which the mineral interests are located would characterize the mineral rights as an interest in real property rather than an interest in personal property.

For example, a “production payment” is considered personal property because it is a bare right to receive income rather than an ownership interest in the minerals comprising the underlying real property. On the other hand, a royalty is considered “like-kind” real property and can be exchanged for any other real property. The primary distinction between these two interests is the term of the respective interest. In the case of a royalty interest, the royalty continues until the oil or gas deposit is exhausted. A production payment usually terminates when a specified quantity of oil or gas has been produced or a stated amount of proceeds have been received.

To qualify for a 1031 exchange, the relinquished property and the replacement property must both have been acquired and “held for” investment or for use in a trade or business. The amount of time that the property must be “held for” is not clearly defined in the Internal Revenue Code.

The position of the IRS has been that if a taxpayer’s property was acquired immediately before an exchange, or if the replacement property is disposed of immediately after an exchange, it was not held for the requrired purpose and the “held for” requerement was not met. This is typically not an issue with farm and ranch sales since the property has generally been owned for many years.

Since there is no safe harbor holding period for complying with the “held for” requriement, the IRS interprets compliance based on their view of the taxpayer’s intent. Intent is demonstrated by facts and circumstnaces surrounding the taxpayer’s acquisition of ownership of the property and what the taxpayer does with the property.

The rules for completing a 1031 tax deferred exchange are:

1. Relinquished Property Must Be Qualifying Property

Qualifying property is property held for investment purposes or used in a taxpayer’s trade or business. Investment property includes real estate held for investment or income producing purposes. Property used in a farm or ranch includes livestock, machinery and equipment. While the rules for “like-kind” real estate are fairly broad, the rules for exchanging other types of property are less flexible. While it is possible to perform an exchange on the sale of livestock and equipment and other types of personal property, the equipment must be exchanged for like-class equipment and the livestock must be exchanged for like-class livestock. For example, bulls must be exchanged for bulls, cows for cows and horses for horses. Saving taxes on the sale of livestock and equipment is often achieved through the use of a Charitable Remainder Trust. This will be discussed in the next chapter.

Property that does not qualify for a 1031 exchange includes:

• A principal residence
• Land under development for resale
• Construction or fix and flip properties for resale
• Property purchased or held for resale
• Inventory property
• Stocks, bonds or notes
• LLC membership interests
• Partnership interests

2. Replacement Property Must Be Like Kind

Replacement property in a 1031 exchange must be “like-kind” to the relinquished property.

A common misconception among many farmers and ranchers is that they must exchange their land into other land. This is not true. Fortunately, the definition for “like-kind” real estate given by the Internal Revenue Code is very broad. Qualifying replacement property can be virtually any real property that will be held by the taxpayer for investment purposes or used in a trade or business. Land can be exchanged for other types of property such as an office building, retail store, industrial warehouse, apartment complex etc.

3. Replacement Property Title Must Be In The Same Name As The Relinquished Property

One must take title to replacement property in the same way they held title in the relinquished property. For example, if a husband and wife own property in joint tenancy, replacement property must be deeded to both spouses in the same manner. Similarly, corporations, partnerships, limited liability companies or trusts must be on the title of the replacement property the same as they were on the relinquished property.

4. Any Boot Received In Addition To Like-Kind Replacement Property Will Be Taxable (to the extent of gain realized on the exchange)

The term “boot” refers to any property received in an exchange that is not considered “like-kind.” Cash boot refers to the receipt of cash. Mortgage boot (also called “debt relief”) is a a term describing an exchanger’s reduction in mortgage liabilities on a replacement property. Any personal property received is also considered boot in a real property exchange transaction.

A taxpayer must not receive “boot” from an exchange in order for the exchange to be completely tax deferred. Any boot received from the exchange is taxable to the extent of gain realized on the exchange.

Boot received can result from a variety of factors. Two of the most common result from “trading down” in a 1031 exchange. Trading down occurs when the replacement property is not of equal or greater value than the relinquished property. For example, if a taxpayer takes cash out of the exchange, or does not acquire a comparable amount of debt on his replacement property as he had on his relinquished property, he will end up trading down because there is not enough cash and/or debt to purchase a replacement property of value equal to his relinquished property.

In summary, if a taxpayer wishes to fully defer tax on an exchange, they must meet two requirments:

1. Reinvest the entire net proceeds in one or more replacement properties. 2. Acquire one or more replacement properties with the same or greater amount of debt. An exception to this requirement is that a taxpayer performing an exchange can offset a reduction in debt by adding cash to the replacement property at closing.

A good way to remember this is to understand that for a taxpayer to defer 100% of the tax in an exchange, they must “trade up or stay equal in debt and equity”.

Some people mistakenly think that in order to perform a 1031 exchange, they must exchange 100% of their sale proceeds. This is not true. It is possible to perform a partial exchange. Performing a partial exchange is often desirable because it may enable a family to pay off debt, diversify their sales proceeds into other investments and provide cash for liquidity purposes. A partial 1031 exchange can also be combined with a Charitable Remainder Trust and a cash sale as part of a comprehensive tax saving and retirement income plan.

In a 1031 exchange, your cost basis in the property you sell (the relinquished property) carries over to the property you exchange into (the replacement property).

A 1031 Exchange Qualified Intermediary (QI), also known as an Accommodator or Facilitator, is a company that is in the business of facilitating 1031 exchanges. In most cases, the use of a QI is essential to the completion of a valid delayed exchange.

When performing a 1031 exchange, a QI enters into a written agreement with the taxpayer. A QI acquires the right to sell the relinquished property on behalf of the taxpayer, completes the transfers of the relinquished property, acquires the right to close on the replacement property and completes the transfers of the replacement property to the taxpayer pursuant to the Exchange Agreement. The QI holds the proceeds from the sale of the relinquished property in a trust or escrow account in order to ensure the taxpayer never has actual or “constructive receipt” of the sale proceeds.

When performing a 1031 exchange, a QI enters into a written agreement with the taxpayer. A QI acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property and transfers the replacement property to the taxpayer pursuant to the Exchange Agreement. The QI holds the proceeds from the sale of the relinquished property in a trust or escrow account in order to ensure the taxpayer never has actual or “constructive receipt” of the sale proceeds.

Anyone who is related to the taxpayer, or who has had a financial relationship with the taxpayer (aside from providing routine financial services) within the two years prior to the close of escrow of the exchange cannot serve as the QI. This means that the taxpayer cannot use his or her own CPA, attorney or real estate agent to complete the exchange. A QI should be bonded and insured against errors and omissions and should utilize safe banking services for the protection of the exchange funds.

If you would like a list of Qualified Intermediaries with experience in performing 1031 exchanges on the sale of a farm or ranch, contact our office at 406-582-1264.

A Build-To-Suit exchange, also referred to as a “Construction or Improvement Exchange” is an exchange in which a taxpayer desires to acquire a property and arrange for construction of improvements on the property before it is received as replacement property. This type of exchange gives the taxpayer performing the exchange the opportunity to use all or part of the exchange funds for construction, renovations or new improvements to the replacement property. In this type of transaction, the taxpayer will contract with an Exchange Accommodation Titleholder (EAT), similar to the reverse exchange described above, to construct the improvements within the exchange period and then convey the improved property to the taxpayer

A Reverse Exchange (sometimes referred to as a “parking arrangement”) is an exchange in which the replacement property is purchased and closed on before the relinquished property is sold. Usually, an Exchange Accommodation Titleholder (EAT) takes title to the replacement property and holds title until the taxpayer can find a buyer for the relinquished property. Subsequent to the closing of the relinquished property, the EAT conveys title to the replacement property to the taxpayer to close out the taxpayer’s forward exchange.

The 1031 exchange is commonly referred to as a tax “deferred” exchange, implying that taxes are not eliminated, only deferred until the replacement property is later sold in a taxable transaction. However, it is possible to potentially eliminate capital gain taxes altogether on the sale of property by exchanging into and holding property until death. Under current tax law, heirs of a descendant’s property receive a “step-up” in basis of the property’s tax basis to its fair market value upon death. This “step-up” in basis could conceivably enable the heirs to inherit property and then sell the property for fair market value soon after the decedent’s death and pay little or no tax. Thus, by employing the 1031 exchange until death, it may be possible to not only defer taxes on the sale of property, but to permanently eliminate them. This is why we often advise our clients to swap until they drop.

Many farmers and ranchers believe the “like-kind” definition for a 1031 exchange means they have to exchange their land into other land. This is not the case. Fortunately, the definition for “like-kind” property is very broad. One can exchange land into other types of investment property.

Like kind property in a section 1031 exchange is not limited to certain types of real estate. The term refers to the nature or character of the property, rather than its grade or quality. Real property must be exchanged for like-kind real property. Real property is not considered like-kind to personal property.

Qualifying Real Property

Any real estate held for productive use in a trade or business or for investment – whether improved or unimproved – is considered “like-kind.” Improvements to real estate refer to the grade or quality, not the nature or character of the real property.

Qualifying Personal Property

Qualifying personal property is more restrictive. In general, qualifying properties must both be in the same General Asset Class or within the same Product Class. For example, cows must be exchanged for cows, tractors for tractors etc.

The numbers of potential replacement properties identified in a 1031 exchange are subject to the following rules:

• Three Property Rule: Any three properties regardless of their market value.
• 200% Rule: Any number of properties as long as the aggregate fair market value of the replacement properties does not exceed 200% of the value of the relinquished property.
• 95% Rule: Any number of properties if the fair market value of the properties actually received by the end of the exchange period is at least 95% of the aggregate fair market value of all the potential replacement properties identified.

There are strict time frames pertaining to the identification and receipt of the replacement property for the completion of a 1031 exchange.

1. 45-Day Rule For Identification: The first time restriction for a delayed exchange is for the taxpayer to either close on the purchase of the replacement property or to identify the potential replacement property(s) within 45 days from the date of transfer of the relinquished property. The identification notice must be by written document (the Identification Notice) signed by the taxpayer and received by the Qualified Intermediary by midnight of the 45^th day. After 45 days have expired, it is not possible to close on any property which was not identified in the 45-day letter. Failure to submit the 45-Day Letter causes the Exchange Agreement to terminate and the QI will disburse all unused funds in their possession to the taxpayer.

2. 180 Day Rule For Receipt Of Replacement Property: The Replacement Property must be received and the exchange completed no later than:

• 180 days after the transfer of the relinquished property or
• The due date of the taxpayer’s income tax return, including extensions, for the tax year in which the relinquised property was transferred.

There is no provision for extension of the 180 days for any circumstance or hardship. There are provisions for extensions for presidentially declared disaster areas.

If an exchange takes place late in a tax year, the 180 day deadline can be later than the April 15 filing date of the tax return. If the exchange is not complete by the filing date, the return must be put on extension to properly extend the deadline for the full 180 days. Failure to put the return on extension can cause the replacement period for the exchange to end on the due date of the return.

Here is an overview of how a section 1031 exchange works:

1. First, the property seller must identify in writing their intent to do a 1031 exchange prior to the closing on the relinquished property. At the closing of the first property the seller includes the exchange language in the buy-sell agreement. This is very important because if you have already sold the property and received any money you will not qualify to do a 1031 exchange.

2. At the closing, sales proceeds must go to a Qualified Intermediary (QI) and are held in a separate account for the benefit of the seller.

3. At this point the seller has 45 days to identify properties for the potential 1031 exchange. This involves written notification to your QI listing the properties’ addresses and/or legal descriptions of the potential replacement properties. (see property identification rules below).

4. The seller has up to 180 days from the closing of the relinquished property to actually complete the purchase of the identified replacement property(s).

5. To fully defer tax on your capital gain, you must purchase replacement property that is of the same or greater value as the property that has been sold. You can do a partial exchange but with a partial exchange you may be subject to tax.

6. To fully defer tax, you must also have the same or greater amount of debt on the new property as the relinquished property. The seller can offset the amount of debt obtained on the replacement property by putting in additional cash in an amount that would be the equivalent to that of the debt.

Office buildings are generally classified into one of three categories: Class A, Class B, or Class C. Each classification represents a different level of risk and return. These letter grades are assigned to properties and areas by factors such as age of the building, tenant income levels and property amenities to name a few.

Class A properties represent the highest quality buildings in their market. They are generally buildings constructed within the last 15 years. They are nice looking properties with little to no deferred maintenance (postponed repairs), the best amenities and the highest income-earning tenants. These properties are usually located in desirable areas and demand the highest rents.

Class B properties are older than class A properties, typically built within the last 15-20 years.   They often have deferred maintenance issues and rent for slightly lower rates than Class A properties. These properties may offer the opportunity for an investor to renovate the property and have it upgraded to Class A.

Class C properties are typically more than 25 years old with much fewer, if any, amenities. These properties often in need of renovation. Because of this, Class C buildings tend to have lower rental rates in a market with other Class A or B properties.

Class D properties are older buildings in less than desirable neighborhoods and potentially dangerous areas. They are older buildings with no amenities, large amounts of deferred maintenance, functional obsolescence, and the tenants can be difficult to work with. Although these properties can offer good cash flow returns, the cash flow is often greatly reduced due to repairs and lack of payment by tenants.

The value of commercial income producing real estate is largely based on the financial security of the tenant. You want to make sure your tenant can pay their rent and meet all terms of a lease. If the tenant defaults on their lease, you could end up with an empty building and you’re stuck with paying all the property expenses. Evaluating a tenant’s credit rating is one way to prevent this situation from happening.

Publically traded companies are assigned letter grades based upon their financial strength. Three of the most reputable credit rating companies are Standard and Poor’s (S&P), Moody’s, and Fitch.

S&P assigns credit ratings that range from “AAA,” which signifies an “extremely strong capacity to meet financial commitments, to “D,” which indicates “payment default on financial commitments.” Investment grade properties have a rating of “BBB” or higher. A BBB rating indicates that a company has “adequate capacity to meet financial commitments, but is more subject to adverse economic conditions.”

Capitalization Rate or Cap Rate is a ratio used to estimate the value of income producing properties. It equals the net operating income divided by the sales price or value of a property expressed as a percentage.

Cap rates are one of many financial tools used by investors to establish a purchase price for an investment property in a given real estate market.

Cap rates based on figures from recent transactions of buyers and sellers provide the best market value estimates for a property. If you are able to obtain reliable cap rate data, you can then use this information to estimate what similar income properties should sell for. This will help you to determine whether or not the asking price for a particular piece of property is too high.

NOI                                                                                       NOI

Cap Rate = ——–                         Estimated Property Value = ————-

Value                                                                                 Cap Rate

Example 1: A property has a NOI of $140,000 and the asking price is $2,000,000.
The Cap Rate = $140,000 / $2,000,000 = 7.00%

Example 2: An office building has a NOI of $150,000 and Cap Rates in the area for this type of property are 8%. Estimated Property Value = $150,000 / 8% = $1,875,000

Net Operating Income or NOI is simply the annual income generated by an income-producing property after taking into account all income collected from operations and deducting all expenses incurred from operations. NOI helps income producing real estate investors evaluate investment properties.

Operating expenses are those costs required to run and maintain a building and the ground it is located on. Operating expenses include items such as insurance, property taxes, advertising, property management fees, landscaping, snow removal, utilities, repairs and janitorial fees. NOI is a before-tax figure; it also excludes principal and interest payments on loans, capital expenditures, depreciation and amortization.

Income properties are real estate investments purchased or developed to generate income through renting, leasing and price appreciation. Income properties can be either residential or commercial.

If you wish to sell your federal building, you may list it for sale just like you would any other type of real estate. If you would like, our team can sell the property for you. There is usually a market for these types of properties.

Yes, we are always able to find available federal government leased properties. The General Services Administration (GSA) is the nation’s largest public real estate organization. As the landlord for the federal government, the GSA owns and leases over 354 million square feet of space in 9,600 buildings in more than 2,200 communities nationwide.

Although there is a large amount of federal leased properties, finding available properties can be difficult. Through our nationwide network of developers, we provide you access to off-market properties as well as properties currently listed for sale. Our proprietary database of federal building owners and developers contains a listing of every federal government leased building in the U.S. This allows us to locate properties in any desired locations you may have. No other firm offers this ability.

The General Services Administration (GSA) is the nation’s largest public real estate organization. As the landlord for the federal government, the GSA owns and leases over 354 million square feet of space in 9,600 buildings in more than 2,200 communities nationwide. GSA negotiates and administers leases on behalf of various federal government agencies, including the Social Security Administration, FBI, DEA, USFS, Department of Homeland Security and others.

The federal government leased office buildings we work are NOT co-ownership real estate investments. They are fee-simple real estate properties you own by yourselves, just like you own your agricultural property.

Most charitable remainder trusts are drafted to allow the donors to change the charitable remainder beneficiaries named in the trust document at any time during their life. A CRT can also be drafted to require you to irrevocably designate a specific charity as a remainder beneficiary for all or part of the CRT.

While you are not prevented from serving as trustee of your charitable remainder trust, it often is better to name another person because you will be subject to some additional restrictions. You can either name another individual, such as a family member, to serve as trustee or appoint a corporate trustee to serve. Many people choose a corporate trustee because they have more investment and administrative expertise. A charitable organization may be able to serve as trustee (sometimes without charge) if irrevocably named as a remainder beneficiary. Regardless of who you select as trustee, however, you can retain the ability to remove and replace the trustee at anytime during the term of the CRT.

CRT payments can extend beyond the donors’ lifetimes. This can be achieved by creating a term of years charitable remainder trust that happens to “outlive” the donor(s), or setting the trust term as lives plus a term of years. The second option (and perhaps the first, depending on ages) would reduce the charitable deduction, and if the settlor does not retain the right to terminate the successor beneficiaries’ interests, there will be a taxable gift to those beneficiaries at the time the trust is created. Finally, adding beneficiaries other than a spouse, results in a loss of the marital deduction potentially causing additional taxable gift.

Statutory rules prohibit charitable remainder trust payouts in excess of 50% of the contributed property and mandate that the percentage must be low enough to ensure that the present value of the interest which passes to charity upon the conclusion of your life (or the selected term) is at least 10% of each contribution to the CRT. This 10% rule only applies when you contribute assets to the CRT. As long as the 10% rule is met at the creation of the CRT, it doesn’t matter if the amount in the trust at a later time falls under 10%.

In addition, rules require the charitable remainder trust payout be no lower than 5%. CRT payouts are determined using an “Applicable Federal Government Interest Rate” at the time of contribution to the CRT and either the age of the income beneficiaries – if the trust is guaranteed for life, or the length of the term – if the trust payout is for a selected period of years.

Generally, you should not select a payout percentage that is too high because if the CRT pays out too much income each year, it will deplete the principal inside the trust and you may receive less income over your life expectancy than you would if you had chosen a lower payout. A good financial advisor working together with a planned giving specialist will help you calculate a payout percentage that is appropriate for you.

Yes, in addition to land, livestock, crops, machinery and equipment can also contributed to a charitable remainder trust.

Sale Of Calves And Crops

Proceeds from the sale of calves and crops are treated as ordinary income and incur self-employment tax (Social Security tax and Medicare tax). The same calves and crops sold in a CRT will defer the income tax and avoid the self-employment taxes otherwise due on the sale. This allows the full proceeds from the sale of the calves and crops to be invested inside the CRT to generate lifetime income for the donors. Contribution of calves and crops to a CRT generally does not generate a charitable income tax to the donor.

Sale Of Cows

Breeding livestock such as cows are capital assets and incur capital gains tax on sale. The same cows sold in a CRT will avoid or defer this tax. This allows the full proceeds from the sale of the cows to be invested inside the CRT to generate lifetime income for the donors. Contribution of cows generates a charitable deduction based on the donor’s basis in them.

Sale Of Equipment

The recapture of depreciation on the sale of machinery, equipment or other depreciated personal property is treated ordinary income. These same assets sold through a CRT will avoid or defer this tax, permitting the full proceeds to be invested to generate lifetime income for the donors. Contribution of machinery or equipment generates a charitable deduction based on the donor’s basis in it.

The income donors receive from a charitable remainder trust retains the character it had inside the charitable remainder trust. Each payment is taxable in one of four categories, in the following order of priority:

First, as ordinary income to the extent of the CRT’s accumulated ordinary income. Second, as capital gains to the extent of the CRT’s accumulated capital gains. Third, as tax-exempt income to the extent of the CRT’s accumulated exempt income. Fourth, as tax-free return of principal.

Trustees of CRT’s will provide you with a Form K-1 showing you how to report the CRT payments on your tax return.

Tax savings are one of the main benefits of charitable remainder trusts. Here are the potential tax benefits from contributing land to a CRT:

An Immediate Income Tax Deduction

Donors of land to a CRT receive an immediate income tax deduction based on the present value of the charity’s remainder interest. The amount of the tax deduction depends on factors such as the fair market value of the trust property donated to the CRT, the amount of the annuity or the percentage of trust assets paid annually by the CRT, the age of those receiving income from the CRT and discount rates set by the IRS.

If you choose a high payout from your CRT, you receive a low charitable income tax deduction. Conversely, if you select a low payout from your CRT, you receive a high charitable income tax deduction. The charitable deduction can be used to offset income tax in the year of the gift, and any unused deduction can be carried forward up to five years. If appreciated property is donated, the deduction each year is limited to 30% of the donor’s adjusted gross income.

Many people choose to leave assets to charity upon their death. While gifts to charity upon death reduce the value of an estate and may help reduce estate taxes, the income tax benefits can only offset income in your estate. The advantage of donating assets to a CRT during your lifetime is you not only reduce the value of your estate for estate tax purposes, you also immediately benefit from an income tax deduction.

State Income Tax Credit

Some states offer a tax credit for charitable planned giving. In Montana, contributions to a CRT restricted to charitable endowments are eligible for a state income tax credit. Montana’s tax credit, called the Montana Income Tax Credit for Endowed Philanthropy, provides a credit against state income tax liability in the amount of 40% of the present value of any planned gift (which includes CRTs) made to a permanent endowment of a Montana charity up to a maximum amount of $10,000 per year per taxpayer.

A strategy used by some taxpayers is to donate the maximum amount of assets to a CRT each year to fully benefit from this tax credit.

Taxes Bypassed On Sale

Assets contributed to a CRT can be sold free of any income tax and Medicare Surtax to the donor. This is particularly significant if the real estate is highly appreciated. By saving capital gains tax, the money that would have gone to paying tax can be invested to generate income for retirement.

Federal Estate Tax Savings

Assets contributed to a CRT will not be subject to tax in the donor’s estate. Thus, future estate tax may be reduced or avoided entirely.   Also, the CRT is not subject to executor’s fees or other probate costs.

CRT Is Income Tax Exempt

A CRT itself is tax-exempt and pays no income tax or Medicare Surtax on interest, dividends, rents or capital gain.

A charitable remainder annuity trust pays a fixed dollar amount each year to the beneficiaries. The trust continues for the life of all income recipients, or for a specified term of years not to exceed 20. Upon the death of all income beneficiaries or the end of the specified term, the remainder goes to the charity or charities named. Since charitable remainder annuity trusts provide a fixed amount paid out each year, this type of trust cannot take advantage of future earnings in excess of the annual payments. However, this trust does offer the security of consistent payments, even in a flat or down market. Due to the fixed payout obligation, additional contributions to an existing CRAT are not allowed.

Here is an example of a Charitable Remainder Annuity Trust income stream with a hypothetical investment portfolio and a 7% payout:

The Charitable Remainder Unitrust

The charitable remainder unitrust pays a fixed percentage of the trust’s value each year. The donor selects the percentage at the time the trust is created. The percentage must be at least five percent but not more than the percentage which allows at least 10 percent to pass to charity.   Following the death of the lifetime beneficiaries, or the end of the term, the remaining trust property goes to the charity or charities named. Unlike the charitable remainder annuity trust, additional contributions to CRUTs are permitted.

Here is an example of a standard Charitable Remainder Unitrust income stream with the same investment earnings and payout rate as the CRAT.

There are two primary types of charitable trusts: the Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust (CRUT).

A common concern among those using a CRT is replacing the wealth that ultimately passes to charity instead of their heirs. This begs the question, is there a way to use a CRT without disinheriting their children? The answer is yes.

For those who wish to use a CRT with the sale of their property and who also wish to replace the value of the assets they donate to a CRT for their children, there are strategies you can use. Some of these strategies may allow you to actually increase the amount of wealth passed to your heirs.

A common “wealth replacement” strategy employed with a CRT is using a portion of the payments from the CRT to purchase life insurance. Premiums for life insurance can often be paid out of the “excess” income generated from the CRT. When I say “excess” income, I am referring to the additional income the donors receive from investing the full sales proceeds rather than the after-tax proceeds.

In using this wealth replacement strategy, donors use payments they receive from the CRT each year to pay premiums on a life insurance policy on their lives with their children and/or grandchildren named as beneficiaries. When the donors die, the charitable organizations named as remainder beneficiaries get what’s left in the CRT and the children of the donors receive the proceeds of the life insurance. And, if the life insurance is set up in an irrevocable life insurance trust (ILIT), the life insurance proceeds are received by your children income and estate tax-free.

A donor transfers appreciated property to the CRT. The CRT then sells the property and since it is a tax-exempt trust, it does not have to pay capital gains tax. The CRT then distributes income to the income beneficiaries. This income can last for the lifetime of one or more people or for a specified term of years.

There are two types of CRTs you may choose to use, a Charitable Remainder Annuity Trust (CRAT) or a

Charitable Remainder Unitrust (CRUT). A CRAT pays a fixed dollar amount of the trust assets each year. A CRUT pays an amount equal to a percentage of the trust value at the beginning of each year, usually 5% to 10%.

When the income beneficiaries die, the remaining money left in the CRT passes to a qualified charity.

The Charitable Remainder Trust is a powerful financial planning tool but there are complex rules involved so it is critical you consult with an expert in planned giving strategies.

To learn more about a Charitable Remainder Trust, read the Wealth Guide on Charitable Remainder Trusts.

A charitable remainder trust is a tax-exempt irrevocable trust that is often used to bypass taxes on the sale of property. There are two sets of beneficiaries with a charitable remainder trust, the income beneficiary and the remainder beneficiary.

To use a charitable remainder trust with for the sale of farm or ranch property, a charitable remainder trust is established and then property is donated to the trust. The trustee of the trust sells the property and pays the income beneficiaries (the farm or ranch owner) either a fixed percentage or a fixed sum of money to the income beneficiaries for their lifetime or a term of years. When the income beneficiaries die, or the term ends, the remaining assets in the trust pass to the charitable beneficiary (ies).

A charitable reminder trust is a valuable tool for a family selling a farm or ranch because not only can you bypass capital gain tax on the sale of appreciated land, you can also bypass tax on the sale of livestock, crops, machinery and equipment using a charitable remainder trust.