With the recent increases in farmland values and drop in real estate prices, some smart landowners might consider selling their farm and purchasing a new home. What are the tax implications of these transactions? The answer depends upon such factors as whether the farm has been the taxpayer’s primary residence or not; and whether the taxpayer has intent to purchase new property of equal or greater value. The Internal Revenue Code provides multiple opportunities for taxpayers to maximize their benefits when selling their property including tax deductions on the sale of the primary residence and 1031 tax deferred exchanges.

Primary Residence

Internal Revenue Code Section 121 allows a taxpayer to exclude up to $250,000 ($500,000 for married persons filing jointly) of the gain on the sale of their principal residence given during the five-year period from the sale date, the home has been owned and used by the taxpayer as their primary residence for periods of two years or more. This exclusion is available no more than once every two years. Those taxpayers who don’t satisfy the two-year ownership and use requirements can exclude a prorated fraction of the $250,000/$500,000 deduction given the taxpayer has a change in health or place of employment. Realized gain is determined by the following two steps:

Step 1:  Original Purchase Price + Improvements = Adjusted Basis

Step 2:  Sales Price – Adjusted Basis – Selling Expenses = Realized Gain

If the realized gain is less than $250,000 (when filing individual federal return) or $500,000 (when filing a joint federal return) there is no tax. If the gain is higher and the taxpayer is in the 25, 28, 33 or 35 percent income bracket, the tax is 15 percent. If the taxpayer is in the 10 or 15 percent income bracket, the capital gain tax may be 5 percent. As always, check with your accountant to confirm the tax consequences.

A principal residence located on the farm can be sold and replaced with a primary residence. Seek guidance from a farm realtor to establish comparable selling prices for the home and farmland.

Tax Impact of Selling the Farm

When selling the farm, there are two types of properties being sold, the land and affixed buildings –real property and equipment or livestock– personal property. Internal Revenue Code Section 1031 allows the taxpayer to defer the capital gains and recaptured depreciation taxes when equal or greater, like-kind real and personal property are replaced within 180 calendar days of the sale.

1031 Exchange

If the intent is replace the real and personal property, replacement property is acquired of equal or greater value. The farmland being sold can be exchanged for any real property in the United States including rental properties, parking lots, oil and gas royalty interests and single tenant, triple net leases such as a CVS Pharmacy or similar tenant. To defer the tax on the personal property, like-kind or like-class personal property would need to be acquired. Each type of personal property falls into one of thirteen general asset classes or six digit North American Industry Classification Code.

1031 Alternative: Deferred Sales Trust

If only the home is to be replaced then the options are to pay the tax on the real (farmland and buildings) and personal property (equipment and livestock) or consider another tax deferral strategy that does not require the purchase of replacement property. A Deferred Sales Trust, similar to a Section 453 installment loan, allows the proceeds of the sale to be invested by the trust in marketable securities and annuities. Investments are determined by the taxpayer and executed by the trust.  Income from the investments is repatriated to the taxpayer on a schedule determined by the taxpayer. If the taxpayer wants a blend of income and gain from the sale, that can be scheduled. Taxes are paid on the income and capital gains received. Taxes on the capital gain are paid over whatever period of time determined by the taxpayer.

After reading Jeanne Marie Laskas great article “Breeding the Perfect Bull” published in the Smithsonian Magazine, I wondered whether a 1031 tax deferred exchange would make sense when selling prize Red and Black Angus, Simmental, Charolais, Hereford, and Senegus bulls. The article is about “Donnell Brown and his fellow cowboys combining modern science with their decades of experience with cattle ranching to create the perfect specimen named Revelation.” Why would a rancher sell a top breeding bull like Revelation? Some of the reasons include genetics, age, injury and the price offered. Ranchers can take advantage of 1031 tax deferred exchanges when selling their animals and purchasing cattle of equal or greater value.

The R.A. Brown Ranch: Creating Top Breeding Bulls

The R.A. Brown Ranch located near the small town of Throckmorton, in East Texas is not your average cattle ranch. Like 97 percent of U.S. cattle ranches, it is also family-owned and operated, passed down to a fifth-generation rancher in a $76 billion beef production industry comprised of about 750,000 independent “cow-calf operations” with fewer than 50 heads. The Brown Ranch operates a 2,000 head farm specializing in breeding. Such ranches are known as “seed-stock providers” representing the beginning of the beef production cycle where genetics determine the qualities of filet mignon, sirloin and steak burgers.

Selling Top Breeding Bulls: Tax Implications

A top breeding bull can sell for $100,000 once their offspring are proven to be prime calves.

What would be the tax implications of the sale? It depends upon the purchase price, the sales price, the depreciation taken and the state capital gains rate. For example, a bull calf purchased for $10,000 and held for five years, depreciation taken for each of the five years resulting in a net adjusted basis of 0. A sales price ranging from $25,000 to $100,000 and selling expenses of $3,000, the estimated tax due is:

Alaska, Florida, Nevada, South Dakota, Washington and Wyoming do not impose a state capital gains tax.

Livestock: 1031 Exchange Benefits and Requirements

If there is intent to replace the bull with like-kind personal property, another bull or multiple bulls, then the taxes due can be deferred in an Internal Revenue Code Section 1031 tax deferred exchange. The IRS like-kind exchange rules require livestock to be:

• Same sex
• Mixed cattle for steer calves
• Cows for mixed yearlings
• Half-blood heifers for three-quarter-blood heifers.

Steps to 1031 Exchange

Before selling or buying in a reverse exchange, talk with your accountant to confirm the estimated capital gains tax. Once you decide to move forward in an exchange, contact a Qualified Intermediary (QI) to ask questions about the exchange and its mechanics. It is important to discuss where the exchange proceeds will be held, if interest will be earned on the account, and what security measures will be in place such as the use of a qualified escrow account and personal identification number to protect the account.

Once the QI is engaged, let them know the contact information of the sale or purchase, perhaps the auctioneer. The QI will prepare exchange documents for the first leg. Exchange funds will be wired to the escrow account under the taxpayer’s tax identification number.

By the 45^th calendar day, the replacement property will need to be identified by providing information on the bull(s). The value of the replacement property must be equal to or greater than the net sales price; otherwise a tax is triggered on the difference.

Contact the QI to let them know the details of when you are closing on the replacement bulls. The QI will prepare exchange documents for the second leg wiring the exchange proceeds to the closing.

Farms and ranches are made up of real and personal property. Depending upon the intent of the owner, land can be sold in a 1031 exchange replacing with a variety of real property choices including real estate and possibly an asset that provides cash flow such as a triple net lease property with a tenant like CVS Pharmacy. In recent years, given the historically low capital gains rate of 15%, paying the tax was and is an option.

If the owner wants to continuing their farming operations, the option starts with their accountant understanding the tax consequences of the sale. What is the value of the real estate, equipment and livestock? Are there water rights, mineral interests, gas and oil rights or easements that can be sold and gain deferred? If gain exists, the gain can be deferred by replacing with real estate and like kind personal property.

The primary residence stands on its own complying with Section 121 and the two year holding requirement to exclude either $250,000 if filing single or $500,000 if a joint return. A rule of thumb used to determine the amount of surrounding land that can be included with the residence is the area of grass typically cut around the home.

The personal property includes livestock and farming equipment. Does the owner want to replace or simply sell and pay the tax on the gain if one exists? The owner may have losses that can offset some of the gain.

A variety of decisions are required when selling farms and ranches and whether a 1031 exchange makes sense. Always seek the input of your accountant when selling real or personal property.

When selling property, there are 4 ways to receive the proceeds. The 4 ways include cashing out, a 1031 exchange, owner financing and an installment sale. All 4 come with potential concerns. For example, when cashing out, taxes must be paid immediately on the proceeds. The client may desire a 1031 exchange but as we know, sometimes exchanges fail and become a taxable event. Owner financing provides an income stream to the seller but the buyer may decide to pay off early and that creates a taxable event the seller may have hoped to avoid. An installment sale also provides pitfalls because the new owner may have a change in circumstances during the installment time period and may decide/be forced to give back the property. Then the seller has to start over and resell the property.

However there is a 5^th option that brokers need to be aware of. That 5^th option is a Deferred Sales Trust. The DST is a great opportunity that can enhance all of the options a seller has to receive proceeds. The DST is a trust that allows the seller to defer capital gains and other taxation on the sale of highly appreciated real estate for as long as the seller would like. Real estate properties can include land, ranches, farms, investment properties, commercial properties, a primary residence or a vacation home. Crops, livestock, timber or an agbusiness can also be sold in the trust.

Here is how the DST can enhance the other 4 options when the seller receives sales proceeds. First instead of cashing out and paying 15%-30% immediately in taxes, defer those taxes by using the DST. The proceeds can still be invested within the trust in the same manner that the seller would have invested outside the trust. However because the taxes are deferred, the seller is able to leverage the entire amount of proceeds to provide a larger cash flow from the trust. For example, $1,000,000 of proceeds in the trust invested @6% generates a $60k a year in income. After tax proceeds of $800,000 invested outside of the trust invested@ 6% generates $48k a year in income. Why wouldn’t someone want to invest in the trust?

The next option is a 1031 and as we are all painfully aware, not all exchanges are completed and that causes an immediate taxable event. A top notch qualified intermediary like Andy Gustafson at Atlas1031 can provide the proper wording to the client that will allow Atlas1031 to send proceeds to the DST should for whatever reason, the exchange cannot be completed. Thus, the DST acts as Plan B and since the seller does not have constructive receipt of the proceeds, the proceeds are not immediately taxable. But it gets better. The seller still has an opportunity to buy more real estate. Because there is no longer an exchange, the seller no longer has to jump through the IRS 1031 regulations and can now buy whatever property he would like whenever he likes. But it could get even better. When looking for financing, the proceeds in the trust might be used as collateral rather than the new property which might encourage the lender to give your client a better interest rate. So, let’s assume that the trust generates a 6% return and the interest rate on the loan is 4%. The income from the trust should be more than enough to service the debt service AND the trust owner still receives 2% from the trust. Everyone wins.

As far as owner financing and an installment sale is concerned, the DST solves the concerns associated with both and is probably a better alternative in almost every case. The only time that a DST probably would not work with an installment sale or owner financing is if the buyer doesn’t have the ability to buy the property outright.

There are numerous marketing opportunities utilizing the DST. For example, how often have you met elderly clients that would like to sell their property and move several hundred miles closer to their grandkids. An exchange doesn’t work and if they sell, there will be several hundred thousand dollars in taxes that they don’t want to pay. The DST may solve those problems and help you make a sale where there may not have been one otherwise.

If a potential client is concerned about finding a replacement property in an exchange, you can offer the DST as Plan B and there’s a real good chance that you will be the one that the potential client chooses to work with if there are several brokers involved in getting the listing.. Another opportunity involves a property with a lot of debt and little basis. If the property is sold, paying off the debt and taxes will leave nothing for your client and he may actually have to write you a check for your commissions. Why would he let you sell his property? If you introduce the DST, there is a way that not only can he sell the property but do so in a way that will still leave him with the proceeds in the trust which can defer his taxes but also provide an income stream to pay off his debt. He is in a much stronger financial position and you not only make a sale but you also get PAID when there would not have been a sale to begin with.

Now, consider the following. You are talking to a potential client that is interested in buying farmland or a timber property for income. Now, I will admit that I don’t know all of the intricacies of taxation in some of those instances but let’s assume that capital gains taxes are involved. The prospect is trying to decide which broker to use. You show him how the DST can help him defer taxation on the income from the timber or crops and guess who gets the business. You do.

Consider this one final example. A client tells you that he is going to be giving some property to a charity whose mission he feels strongly in through his will when he passes on. That’s great but there is no selling opportunity. Wrong. Consider telling him this. Mike, if I can show you how both you and your charity will be better off by letting me sell the property for you now rather than waiting until you die and giving it in your will, would you be interested in discussing that idea. The idea involves the DST and don’t hesitate to get your listing agreement ready because he will love your idea.

A famous Hollywood actor once said, “I’m proud to be paying taxes in the United States. The only thing is-I could be just as proud for half the money.” All he had to do was call you.

When selling a capital asset, it is critical to include the tax consequences of the transaction in the decision making process. Three taxes are typically triggered when a capital asset is sold including federal and state capital gain and recaptured depreciation. These taxes can represent upwards of 40% of the sales price and more if the asset is held less than one year. Such states as Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming do not have a state capital gains tax but federal capital gain and recaptured depreciation taxes will still apply to the sale. A 1031 exchange allows deferring the above-mentioned taxes until the sale of the replacement property.

Benefits and Risks

1031 exchanges can be initiated over and over, effectively deferring to your beneficiaries at death. Given our country’s debt issue, raising taxes will most likely be a part of the long term solution. The risk is whether the property acquired will appreciate and generate adequate income to exceed a higher capital gains rate.

Currently, the federal long-term capital gain tax rate on real property for taxpayers in the 25, 28, 33 and 35 percent brackets is 15%. Long-term capital gains is the federal income tax on assets held for one year and a day while short-term capital gains tax rate is the taxpayer’s ordinary income tax rate. Taxpayers in the 10 and 15 percent brackets pay 5% on long-term capital gains.

Effective January 1, 2013, the federal capital gains rate is scheduled to increase to 20%. An additional 3.8 percent Medicare tax will apply to those with an adjusted gross income exceeding $200,000 for single and $250,000 for married filing jointly taxpayers.

Example: When Benefits Outweigh Potential Risks

A married couple filing a joint return, has an adjusted gross income above $69,000 (in a 25-percent income bracket):

• They sell a rental property purchased for $200,000 for a sales price of $400,000. This triggers a realized gain of $180,000 and capital gains and depreciation tax of $35,120 in 2012.
• In a 1031 exchange, the gain of $180,000 is deferred by acquiring a property of equal or greater value. The new property is purchased for $400,000 and later sold for $500,000 after a year or more.
• The property’s basis is reduced by the $180,000 realized gain of the first property and the replacement property sale results in a realized gain of $278,000 or capital gains and depreciation tax of $65,552.

The 1031 exchange represents an interest free loan of $35,120, with the return on the investment appreciating at 3.0 percent or $1,053 per year. The return is woefully smaller than the $13,400 tax resulting from the higher capital gains tax. However, if the taxpayer wants to acquire a replacement property to continue deferring the gain, the exchange will be beneficial, given the longer the property is held, the more likely it is to justify deferring the higher capital gains tax with another 1031 exchange. If the taxpayer does not want to acquire another property, then it may make sense to pay the historically low federal capital gains tax of 15% along with the recaptured depreciation tax.

Deferred Sales Trust

Another option is a Deferred Sales Trust to defer the capital gain and depreciation taxes. Deferred Sales Trusts can defer the gain on primary residences above the Section 121 $250,000 and $500,000 exclusion and on highly appreciated second homes.

Landowners hold land for a variety of reasons including conservation, investment, cash flow and personal enjoyment. When intrinsic values change, it may be time to consider selling. If the intent is to replace current holdings with another type of real property, landowners can save money by using a tax deferment tool, also known as a 1031 exchange. Within the scope of eligibility for tax deferment, landowners have multiple replacement options such as building on land already owned, buying land and constructing improvements, replacing with single tenant, triple net leases such as CVS Pharmacy, Walgreens and a sale leaseback.

What Section 1031 Says

According to the Internal Revenue Code Section 1031, “no gain will be recognized on property held for productive use in business or investment when exchanged for like kind property held for productive use in business or investment.” Property denotes real and personal property. Real property is any type of real estate that is considered real property by the state. Examples of like kind real property exchanges include:

• Some states recognize perpetual water rights as like kind to a fee interest in real property
• Farmland is exchangeable for a tenants in common interest in commercial buildings
• 30 year leasehold interest or more is considered real property.

Tangible and intangible personal property held for the proper intent is also eligible but must be exchanged for like kind or like class personal property. Examples are:

• Unallocated gold bullion for Canadian maple leaf gold coins
• Furniture for furniture
• Half-blood heifers for three-quarter heifers
• FCC television licenses for FCC radio licenses.

Each of the replacement options share a likeness of physical properties, character of title conveyed, rights of the parties and period or duration of interests.

Replacement Property Options

Landowners can consider the following replacement options when selling real property:

Build on Property Already Owned
An Exchangor can acquire constructed improvements given the property is purchased from a third party as in a leasehold improvement exchange. The Exchangor cannot acquire property from himself in a 1031 exchange. The IRS does not recognize labor and materials as like kind to real property. Adequate planning is required at least six months prior to initiating this type of exchange unless the land is owned by a related party.

Improvement or Build to Suit Exchange
Property with improvements constructed to the design specifications of the Exchangor satisfies Section 1031 requirements given the property is transferred in exchange for other real property of equal or greater dollar value. A tax is triggered on the difference should the new property be of less value to the old property.

Single Tenant Triple Net Lease
The replacement property is either a new or existing commercial building with a tenant such as a CVS Pharmacy or like tenant who leases the property and is responsible for insurance, utilities and taxes.

Sales Leaseback
A sale of the Exchangor’s property is followed by a 30-year leaseback of the same property and subsequent purchase of a replacement property. This allows the Exchangor to sell his real property, retain use, and reinvest sales proceeds in a replacement property while deferring the capital gain and or recaptured depreciation taxes.

Exchangors are advised to seek the counsel of their legal, tax and real estate professionals prior to engaging in options described to understand the tax consequences and state statutes.

The Internal Revenue Code provides multiple tax deduction and deferment solutions for asset owners including Self Directed Individual Retirement Accounts (SDIRAs) and 1031 exchanges. Each option has its advantages and disadvantages, and the appropriate solution depends on the current asset ownership and the need for self-usage of the property.

SDIRAs have two primary advantages over 1031 tax deferred exchanges. First, the United States government allows the write off or tax deduction of any contribution for most IRAs. Second, when the SDIRA sells the appreciated asset, there is no tax due (unless purchased with a loan, then Unrelated Debt Finance Income (UDFI) or Unrelated Business Income Tax (UBIT) may apply), those profits are returned to the SDIRA. 1031 exchanges are the appropriate strategy when selling an investment property already owned and when debt is needed to acquire the replacement property. Disadvantages of a SDIRA are debt must be non recourse and there can be no self-usage of the property.

SDIRA Asset Types

SDIRAs have been around for over 30 years allowing individuals to invest in a variety of non traditional investments including:

• Single and multi unit homes
• Livestock
• Commercial property
• Improved or unimproved land
• Mortgage, note or accts receivable
• Foreign property investment
• Tax liens
• Gold or silver
• Private placements
• LLC and partnerships

Investments in collectibles such as artwork, rug or antique, metal or gem (the exception is gold, silver, platinum and palladium bullion), stamp or coin or any alcoholic beverage and insurance are prohibited.

Self-Directed Retirement Plans

The types of retirement plans that can be self-directed and the current contribution limits are:

Rules & Regulations

SDIRA owners should follow three primary rules in their investment activities. First, there can be no self dealing or personal use of the SDIRA asset. This includes parents, grandparents, children or grandchildren of SDIRA owner and/or spouse. Brothers, sisters, Aunts, Uncles, Cousins can use the property at fair market rent. Second, debt must be non recourse to the SDIRA (the titleholder is the SDIRA) which limits the number of available lenders. Third, the SDIRA cannot engage in any transaction (direct or indirect) with anyone related or considered a disqualified person. Examples of disqualified persons include:

• You and your spouse
• Lineal ascendants and their spouses
• Lineal descendants and their spouses
• Any fiduciary of the SDIRA
• Anyone providing services to your SDIRA
• Corporations, partnerships, trusts, or estates in which you own, directly or indirectly, at least 50%.

Basic steps to buy real estate or asset in a SDIRA are:

1. Open/contribute or roll over funds from an existing plan held with a broker to a SDIRA.
2. Locate investment.
3. Make an offer on behalf of SDIRA.
4. Complete buy direction letter.
5. Review and approve title documents.
6. Deed recorded in SDIRA name for example, Entrust Freedom LLC FBO Client Name, IRA #12345.
7. Expenses paid from SDIRA.

Regulations require that third party custodians provide SDIRA account administration including annual reports to the IRS. The Entrust Group is an old established administrator with competitive fees. They provide free consulting on the many rules and effective strategies such as holding the asset in a limited liability company with checkbook privileges.

A 1031 exchange is defined by the Internal Revenue Code (IRC) Section 1.1031 as “No gain will be recognized on property held for productive use in business or investment when exchanged for like kind property held for productive use in business or investment.” This means property either real or personal property held for the proper intent can be sold and gain deferred when real or personal property is acquired. The result is the federal and state capital gain and recaptured depreciation taxes are postponed, deferred until the sale of the replacement property. This deferral is referred to by the Internal Revenue Service as a tax free exchange given no tax is paid.

1031 Exchange Requirements

There are many 1031 exchange rules depending on whether real or personal property, US resident or non resident alien, forward or reverse exchange. Common to all 1031 exchanges are the following rules:

• qualified intermediary is required by the IRS to correctly structure the exchange
• a related party to the taxpayer either by family (siblings, spouse, or lineal descendants) or entity should more than 50% of the value of stock is directly or indirectly owned by an individual must hold the property acquired for two years and if selling the replacement property must also be initiating a 1031 exchange
• a disqualified person is prohibited from acting as a qualified intermediary
• proper intent implying property is held for qualified use
• Foreign nonresident must comply with FIRPTA requirements when selling U.S. real property
• net equity and debt retired at sale is equal to or greater in the replacement property, otherwise the difference is taxable
• replacement property is identified by the forty fifth calendar day post closing preferably to the qualified intermediary
• the exchange period ends on the 180th calendar post closing unless a presidentially disaster notice is posted on the IRS website defining the effected counties
• the taxpayer who sells is the taxpayer who buys
• real property is exchanged for real property while personal property is exchanged for like kind class and character of personal property
• US property is exchangeable for property in the US while international property may be exchanged for property internationally
• conveyed rights must be essentially alike including character of title conveyed, rights of parties and duration of interests
• taxpayer cannot receive, pledge, borrow or otherwise obtain benefits of the exchange account per § 1.1031(k)-1(g)(6).

Depending upon whether the exchange is a forward, reverse, simultaneous or leasehold improvement will determine the steps the qualified intermediary will use to accommodate the exchange in accordance with IRS regulations.

1031 exchanges can be simple and complex, yet each must comply with IRC 1031 requirements. Every year Regulations, Revenue Procedures, Revenue Rulings, Private Letter Rulings, Technical Advice Memorandums and other types of advice is provided by the IRS to assist interpreting the 1031 statute. Work with a qualified intermediary current on case law interpretations to assure appropriate guidance and accommodation.

Do you qualify for a 1031 exchange?

Here are several broad principles that usually — but not always — apply in these decisions.

1. Don’t sell when there are a lot of properties like yours for sale in your area, unless you are in a hot seller’s market.

Competition among many sellers with essentially the same product inevitably means advantage to buyers. That usually plays out in a buyer playing off one seller against another. In a buyer’s market, the seller’s asking price will be discounted and his ability to hold to a wanted price is weakened.

Unfortunately, the economic forces that depress the economy and real-estate sales in particular, also corners sellers into having to sell their property because they have to.

If you don’t have to sell in today’s market, don’t put your place up for sale. Wait.

2. Sell investment property when you can use the sale profit to make a better investment.

This requires that you have a reasonable sense of how the property you own will appreciate in the future as well as how your next target property is likely to appreciate. This amounts to combining trend analysis with a crystal ball.

Consider using a 1031 exchange to protect your gain going forward.

3. Sell when you’re sick of fooling with a property you hate.

Some properties are just one headache after another. If they’re making money, you have to decide whether you value the net (not the gross) more than the headache. I start getting headaches when dealing with house tenants, but that’s just me. I’ve had good experiences with hunting and pasture tenants.

Fix-up places are always good candidates for headache properties, particularly if you’re living in the middle of the work…and you’re married.

4. Sell when all the other choices you have are worse.

Things don’t work out well sometimes. And at other times, things work out so badly that you have to choose between dreadful alternatives to muddle through.

The one time I was in that situation I found that making a decision to sell a very smart real-estate investment into a bad market was made for me. I had no other choice.

At such a point, you do what you have to do, sell what you have to sell, and don’t waste time and energy stewing.

5. Sell investment land when you don’t have to.

Lack of pressure on sellers to sell provides flexibility and the ability to hold for the right deal. When you’re in this fortunate position, look for advantage in terms if you and the buyer get stuck on price.

6. Sell farther out rather than closer in.

My experience has been that every single land investment I’ve had over 40 years would have sold for more if I had held it longer. I cannot say the same for stocks, that’s for sure.

How will I fund a land investment?
Those beginning the process of purchasing land usually have a general idea of how they plan to pay for the investment. However, I have seen many buyers change their method of funding because they became educated on an option that was previously unknown to them and offered them some distinct advantage. Some may simply not understand the process or what they can afford. Following is a brief explanation of the most commonly used methods to fund land transactions.

Cash – Most land transactions that I work with are cash transactions. This is not to say that I work with only the independently wealthy. Most people that pay cash for a property have recently sold some other type of investment and are simply moving that investment into a property that works better for them. Many investors prefer this method as it is the most hassle-free and gives the buyer a negotiating advantage—The general thought is that a cash offer is stronger and that because the terms of the offer are stronger, the investor can offer a lower price.

1031 Exchange – 1031 exchange, Like-kind exchange, Starker exchange, Tax-deferred exchange—all refer to a method of exchanging a property or properties for other similar properties without the realized capital gain being recognized as taxable by the IRS. This is only available to those who hold the property for a business purpose. In the past few years, this has become very popular with investors seeking to grow their investment portfolios without taking cash out. For example, if you sell a farm that you have operated in Texas, you can utilize a 1031 exchange to move that money into a timber property in Alabama. There are many special conditions that must be adhered to in order participate in a 1031 exchange. You should consult your attorney regarding a potential 1031 exchange prior to accepting an offer from someone to sell the property you will be selling in the exchange.

Home Equity – In most of the land deals that I work with, the buyer is purchasing a property that will not be, at least immediately, their primary residence. Most of these buyers also have signifigant equity in their current primary residence. A home equity loan on the buyer’s primary residence offers many advantages over a traditional land loan. First there are the tax benefits from using the interest on the loan on your income taxes. Also, when a buyer is using a home equity loan, that buyer can go through the loan process prior to making an offer. Since the buyer then knows how much money he or she has avialble for the purchase, they can make an offer as a cash offer, which strengthens the buyer’s postion in negotiations. Many times you can get more favorable terms on a home equity loan than on traditional land loans as well. It also makes your investment in land more liquid since to sell it, you will not have to then pay off a mortgage on it- so if the right opportunity comes along, you can liquidate your invesment and roll that money into whatever it is that you wanted…just like you had bought the property with cash. Most banks, credit unions, and mortgage brokers offer home equity loans.

Land Loans – Land loans are those loans that hold the land itself as collateral. Whereas many times you can buy a home with 5-10% downpayment, most times you will need 15-30% of the purchase price as downpayment to get a land loan. Land Loans typically have a slightly higher interest rate than you can get on a home equity loan or regular home mortgage, however, many institutions that specialize in land lending are becoming more competitive with the conventional home loan market. Local banks (local to the property) are a good source for land loans, as well as lending cooperatives like the Federal Land Bank, and the Farm Credit System. My experience with land loans is that you want to work with a lender that understands land and land issues. Most, not all, mortgage brokers and loan officers are not as experienced in land lending as are those that work for companies that specialize in that segment of the industry.

Owner Financing – Many times buyers and sellers find advantages in owner or seller financed transactions. This typically occurs by the buyer making a down payment to a seller on a property. The seller then conveys the property to the buyer, with the seller holding a mortgage on the property until the buyer pays the remainder of the amount due. Terms and conditions of owner-financed sales can vary greatly. In my experience, sellers usually want 15-20% down payment from the buyer and an interest rate that is slightly above what rates are in the conventional markets. Repayment terms can range from monthly payments over 30 years down to a single payments soon after the initial transaction. This must be worked out between the buyer and seller. It is important to note that not all sellers are willing or able to offer this option on a property. The buyer should be sure to perform the same due diligence that a lending institution would require to protect themselves from potential pitfalls in owner financed transactions. Owner financed sales are advantageous to some sellers because they can differ some of the income from the property and get a steady stream of income over time. Buyers benefit since most owner financed sales do not typically involve credit checks, origination fees, and the hassle of dealing with a lender.

Lease Purchase – Some properties are contracted for in a Lease/Purchase Option contract. In this type of arrangement, the buyer leases the property from the seller for an agreed upon timetable at the end of which the buyer can elect to buy the property or forfeit their money paid to the seller until that time. Sometimes these arrangements do not leave the buyer with an option to buy, but rather an obligation to buy at the end of the lease period. Typically, monies paid as rent and for the option are deducted from the purchase price, but this is not a requirement. In this type of arrangement, title to the property does not pass to the buyer until the end of the lease period, when the buyer exercises their option to purchase the property. Usually there is interest charged by the seller on the principal amount due during the lease period. It might be helpful to think of this as “Rent to own”. Again, not all sellers are willing or able to offer this arrangement. Also, it is important that the buyer performs sufficient due diligence in checking out the property, as well as the seller of the property, since the seller will retain title to the property during the lease period.

There are many other options for funding land transactions and are limited only by the creativity and the acceptance of the parties to the contract. Sometimes transactions are negotiated in broad strokes, sometimes deals worth hundreds of thousands of dollars hinge on something as small as who pays for inspecting the title to the property. One creative manner of funding a land transaction is through the use of your 401K funds or IRA funds…and you can do it without incurring Federal taxes for transferring the investment. I will examine that further in a later post.