After speaking for a conference several years ago, a fellow advisor came up and asked me about a client of his selling a $40 million farm. Doug (name changed for privacy reasons) then went on to ask, “Is there anything that can be done to reduce, defer, or even eliminate the tax on the sale of my client’s farm other than using a Section 1031 exchange?”
After a few more minutes of asking questions about the proposed sale and understanding more about the family and their objectives, I suggested the consideration of a strategy we’ve now used several times.
The strategy comes from an obscure section of the tax code and is one earmarked exclusively for those in the ag space. Further, it not only applies to deferring taxes on the sale of land but also to tax deferral on the sale of production (crops, fruit, animals, wine, cannabis, timber, etc.) stemming from day-to-day agricultural operations.
Simply put, this strategy, which I call the “Thank You to Ag Tax Break” or “TY2Ag,” defers the recognition of taxes on land and production for 30 years while still giving the seller 94% of the net sales proceeds within 7-10 days of escrow closing.
Wow … deferring the recognition of capital gains or ordinary income tax while getting 94% of the net sales proceeds in your hands NOW to use for whatever … Imagine That™!
Instead of a 1031 Exchange on the farm, try...
So a little background … the Smiths (again, not their real name) have a lovely farm that has been very productive, but the family is ready to close the door. Dad is in his 70s and wants to slow down. His children aren’t interested in doing the often backbreaking work of farming, especially when they can receive an enormous payday to allow them to do other things. We’re seeing this happen all across the country in California, Nebraska, Oklahoma, Texas, New Jersey, Washington, Oregon, and everything in between.
But, most real estate agents are only aware of using IRS Code Section 1031 to defer the recognition of tax on the sale of an asset. However, in addition to that IRS Code Section, there are actually six to seven additional ways to sell appreciated real estate and not pay taxes or not pay taxes right away on the sale.
For today’s newsletter, we’re going to focus on the idea that we used for the Smith family but understand that there are, as said, a number of other techniques we could use (or consider) as well. Just none that work as well for those in ag.
Congress, the IRS, & Agriculture
Growing up in Yakima, Washington, I have worked with and respected members of the agriculture industry from early childhood. No one works harder or has more things out of their control than those in ag. Congress has recognized the special role and challenges that those in ag face and provided various incentives to help.
One of those special strategies I discovered about six years ago. My uber clever advanced planning friend, Randy Fox, and I were jointly presenting at a conference on the use of various tax mitigation techniques, and he shared several ideas I had never seen before … including this little-known section of the tax code built specifically for our friends in ag. As soon as we got off the platform, I tied his shoes together and made him tell me everything he knew about this idea. Brilliant! (Gosh … I hope I untied his shoes after that!)
This tax break allows farmers/ranchers/growers/horticulturalists/vintners, etc. to use these special rules to sell appreciated real estate and/or their production. It allows ag sellers to defer the tax recognition for up to 30 years. At the same time, they getting 94 cents of every net dollar in their hands … with no special requirements or red tape!
I wanted to know, “Why 30 years?” And, as I dug into the IRS code more, I discovered that Congress actually leaves the deferral period open-ended. That is, the tax code does not give a specific number of years but leaves it undefined. Over time, however, best practices suggest 30 years to be a meaningful time frame … it’s long enough to be very helpful to the ag seller but creates an ending point for which to “neatly conclude” the transaction.
Thirty years is a very long time to defer any taxes and grow the money. As the saying goes, “pigs get fat, hogs get slaughtered.” No need to get excessively greedy, in our opinion. So 30 years it is!
To give some further background, shortly after the income tax system in the United States was put into place, it was observed that if someone sold an asset but received their payments in installments, they should only have to pay tax on the installments when they receive them. So IRS Code Section 453 was created to address the ways in which a seller could defer the recognition of tax until the payment was actually in their pocket and spendable.
Fast forward to the late 1980s. (It just happens to be my wife’s favorite decade for music and otherwise.) Congress put into place some special rules meant to help anyone selling their land in the agriculture industry (think farmers, ranchers, dairy, cattle, lumber, etc.) Later on, Congress implemented extra provisions to allow those in the ag industry to defer the recognition of ordinary income tax on their production as well (think sale of timber, grapes, cattle, wheat, grain, almonds, etc.)
Remember, at the beginning, the family with the $40 million farm? They were considering using 1031 exchange for a portion of the sale and paying taxes on the rest. In their state, between taxes payable to the US Government as well as the state, the tax bill was going to be nearly $16 million! Clearly, there was room for some creative thinking to be applied!
Advantages of the Thank You To Ag Tax Break
There are significant advantages to using the TY2Ag over a 1031 exchange.
- 1031 only works on the sale of land and does not apply to the sale of production!
- It is not possible to defer taxes on the sale of production ordinarily UNLESS you are in the ag industry, which is the only exception to the rule
- Even though it provides a lengthy tax deferral, TY2Ag gets the seller immediate cash
- In a 1031 exchange, the adjusted basis in the property has to be carried forward, and if the asset has been held for some time, that may leave little to depreciate going forward
- With TY2Ag, however, the cash in hand can be used to buy a brand new asset, with a fresh new basis to maximize after-tax income
Is There A Limit On The Size Of The Transaction?
Maybe. The largest transaction we’ve seen so far for this type of sale was over $4.8 billion. This was a publicly traded corporation using one of the “Big 4” national CPA firms as their tax counsel.
We have since compiled a list of many different entities in the ag industry that have used this same TY2Ag technique.
Most are far below $4.8 billion, but there are many other multi-billion dollar sales that we can reference. Similarly, the tax savings are in the billions, and the accounting help for these public companies are the best and brightest in the field of public accounting. (Email us, and we’d be happy to send you the list!)
This is not to discredit any professionals suggesting a 1031, nor is it meant to discredit the use of that strategy. TY2Ag, for those in the ag industry, is vastly superior to a 1031. In addition, as noted, 1031 exchanges do not work for the sale of production by those in the ag industry. This area may ultimately be more extensively used than the actual sale of land!
How Much Will I End Up With?
As said above, ultimately, the sellers will receive 94% of the net sales proceeds within 7-10 days of the close of escrow. So even though the payment of the tax is deferred for 30 years, 94% of the net sales proceeds are available virtually instantaneously to be used in any manner the seller wishes.
Moreover, there’s none of the pressure and stress that comes with the compressed 1031 exchange time frame. Namely, you get to avoid the headache of identifying the qualified replacement within six weeks and closing the purchase of the replacement asset within six months.
What About Risks?
Regrettably, there are those who have attempted to apply the special rules meant for those in the ag industry to sell appreciated real estate in other contexts. While there are some less powerful strategies just for selling appreciated businesses and real estate not in the ag industry, the strategies and structures are not nearly as effective as Thank You to Ag Tax Break.
There are ways in which things can be done correctly. There are ways things can be done in a bungled-up fashion. This is not a strategy you should attempt at home. To pull this off, you need to make sure you are using specialists who know exactly what they are doing. Ideally, they have also received IRS approval on these transactions in the past. For example, our team includes:
- Us
- Our partner law firm
- Specialize trust company
- Other experts in this niche, depending on the sale specifics
Remember all of those cute commercials with the “Don’t try this at home!” tagline? The same wise counsel covers TY2Ag as well. This is not a strategy you should attempt at home while drinking beer on the sofa!
TY2Ag is not a panacea. While variations of this technique can be modified for those not in the ag industry, the specific benefits described in this article are just for those in the ag world.
We’re intentionally leaving out some important information. We’re a consulting firm that is here to help, but we also have to make sure we get paid for our creativity.
If you’re getting ready to sell the farm (or the winery, or the ranch, or the timber lot, etc.), reach out to schedule a complementary 20-minute consultation to see if the Thank You to Ag Tax Break will fit your scenario and your long-term goals or forward this to a friend.
Because what could you do if you were to defer the tax recognition on the sale of your ag land and/or production for 30 years … Imagine That™!
Imagine That™! is a complimentary monthly newsletter provided by Wealth Legacy Group®, Inc. that addresses various topics of interest for high-net-worth and high-income business owners, professionals, executives and their families. Sign up to receive our monthly newsletter here.
R. J. Kelly, Wealth Legacy Group®, Inc. – July 2023
Header image on Canva, one design use license