Investing Proceeds From The Sale of a Farm or Ranch

You’ve worked hard to create the equity in your farm or ranch. When it comes time to sell, you need to work smart to preserve that equity and to make your money work as hard for you as you have worked for it.

I grew up working on ranches in Lewistown, Montana. As a financial advisor for over 27 years, I’ve spent much of my time working with agricultural families and their unique financial needs. In my experience, farmers and ranchers are hard working, industrious, self-reliant and frugal individuals. Most, however, are not proactive at engaging in financial planning and have little experience investing in assets outside of their farm or ranch. Consequently, many families end up paying large amounts of taxes on the sale of their property and earn inferior investment returns on the sale proceeds. While self-reliance and frugalness may have served these families well during the years of operating their ranch, failing to plan with the right team of advisors prior to a sale can end up costing them financially.

There are significant tax consequences to selling a farm or ranch that has appreciated in value. Financial tools can help defer or avoid these taxes. Money that would have gone to taxes can instead be used to generate income and provide an inheritance. To benefit from these tools, however, you must be proactive and engage in planning well before a sale takes place.

You may be tempted to invest sale proceeds in things you are comfortable with such as land and certificates of deposit. Even though land has served your family well, it may not provide the cash flow returns that other commercial real estate investment strategies are designed to offer. Likewise, while CDs are “safe” investments, they have not provided returns that have kept pace with the rate of inflation.

Hypothetical ranch sale

The following is a hypothetical example of what a family may be able to achieve when selling their farm/ranch but is not representative of all situations.

Bob and Mary, ages 67 and 65, owned a ranch in central Montana. Their two children were grown, had their own careers and weren’t interested in taking over the ranch. Bob and Mary deeply loved their ranch but had an increasing desire to travel and spend more time with their kids and grandkids. Bob’s back pain was interfering more each year with his ability to operate the ranch and calving season was beginning to take a heavy toll on his health. After much emotional deliberation, they decided it was time to sell.

Throughout the years of operating their ranch, any profit from their operation went back into purchasing more land, cattle and equipment. When Bob and Mary listed their ranch for sale, the value of their home and ranch assets represented nearly 100% of their net worth. The value of their land had greatly increased and based on a tax projection from their CPA, Bob and Mary faced a tax bill of over $600,000 if they were to cash out.

Bob and Mary’s CPA referred them to an advisor who owned an independent wealth management firm that specialized in working with agricultural families selling their ranch. After several meetings with the wealth management consultant, their CPA and their attorney, Bob and Mary decided to utilize a 1031 Exchange and a Charitable Remainder Trust (CRT) to reduce the tax burden on the sale and to provide them with a tax-efficient income and retirement plan.

The ranch sold for $5.2 million. Bob and Mary did a 1031 exchange for $2 million into an office building leased to the Social Security Administration. This building offered a 10-year lease guaranteed by the federal government and generated a first year income, after all expenses, of $150,000. $1.5 million worth of land, cattle and equipment was sold through a CRT. Because the CRT is a tax-exempt entity, the proceeds sold in the CRT were not subject to tax. With the help of the wealth management consultant, this $1.5 million was invested in a diversified portfolio of mutual funds within the trust for the benefit of Bob and Mary. They chose a 7% payout rate with the CRT, which provided them a first year income of $105,000.

Bob and Mary paid tax on the remaining sale proceeds. This tax was largely offset by the charitable income deduction they received from making the gift to the Charitable Remainder Trust. They were also able to withdraw $300,000 tax-free from the sale of their home through the Personal Residence Exclusion. By using the 1031 Exchange, Charitable Remainder Trust, Personal Residence Exclusion, and other tax saving strategies, Bob and Mary reduced their tax bill from over $600,000 to less than $100,000.

The net cash available after paying tax and investing in the Social Security building and CRT was $1.4 million. They used $490,000 of this cash to purchase a new home on a small acreage in central Montana and a second home in Arizona. Something they long desired but never had the cash or time to do was to take their kids and grandkids to Disneyland. They used $20,000 to take this long awaited trip. They deposited $50,000 into a money market account. The balance of the funds was invested in a diversified mutual fund portfolio comprised of 40% stock and real estate funds and 60% bond funds. From this portfolio, they made annual distributions of 7%, providing a first year income of $77,000.

From their annual income, Bob and Mary made annual gifts to a college savings plan for their grandchildren. They established a small college scholarship fund for their local high school graduates. They purchased a $1 million second-to-die life insurance policy on their lives to replace the money gifted to their CRT. Their attorney and life insurance agent helped them set up an irrevocable life insurance trust so their kids could receive the proceeds from the life insurance both income and estate tax free.

For the first time in their lives, Bob and Mary had the ability to travel for extended periods of time. Bob was able to take his son on a hunting and fishing trip to Alaska they had long dreamed about and Mary was able to take a long awaited trip to Hawaii with her daughter. They enjoyed an annual income that far exceeded what they ever made on the ranch and Bob didn’t have to pull calves or feed cows in the wet and cold weather to earn it. Besides enjoying a comfortable retirement and providing a large inheritance for their children, Bob and Mary had the joy of knowing that when they both passed on, the charitable remainder trust they established would provide a large amount of money to support their church and the Yellowstone Boys and Girls Ranch Foundation.

Annual income

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