Options to trim or eliminate taxes on income and estate
Farmers and landowners split into different sessions at the Land Expo, and those who selected the income and estate tax presentation came armed with pens, paper, and questions.
Paul Neiffer, a certified public accountant and business adviser for CLA – CliftonLarsonAllen, fielded the questions and broke down the nuances for routes of deferring or eliminating estate and income taxes.
Neiffer prefaced his presentation by noting that strategies could be shaken up depending on the result of the 2020 presidential election and from different options being ironed out as they receive more exposure.
Neiffer points out farmland investments as a key factor for 1031 exchanges. Neiffer uses farmland with tile as an example for Midwestern farmers.
Tile falls under Section 1245 as real property. In the example, you sell the land for $3 million with the tile worth $500,000. As an investor, you decide to put that money into more farmland that’s worth $3 million without tile or any other Section 1245 property.
In this situation the investor will incur a taxable gain of $500,000 from the tile because the reinvestment didn’t include any Section 1245 property, according to Neiffer. If the investor owns farmland with no Section 1245 property and sells it to buy a farm with Section 1245 property, then the investor avoids the $500,000 taxable gain.
“You can’t go from having 1245 property into land or other assets that don’t have 1245 real property [without taxable gain],” Neiffer says.
Neiffer rattles off a list of Section 1245 real property examples that relate to agriculture, including tiling, hog buildings, grain bins, and more.
The exchange also presents flexibility with the Section 1245 property. The type of property can be different from one side of the exchange to the other. For example, grain bins can be matched with tiling; it doesn’t have to be grain bins for grain bins to offset the taxable gain.
Opportunity zones isolate areas with the goal to inject economic activity in areas with lower income.
Neiffer uses an example of selling farmland to generate a $1 million gain. An opportunity zone lends itself to deferred tax payments, a reduced capital gain, and an elimination of appreciation on the taxation with the investment.
With the deferral, if the gain is reinvested within 180 days, you don’t have to pay the tax until the end of 2026 or whenever you sell it, whichever comes first, Neiffer says.
Neiffer also says holding the investment for at least five years reduces the gain that’s taxable by 10%.
Lastly, the biggest plus of the opportunity zone, according to Neiffer, is the benefit after 10 years.
Neiffer uses an investment held for 10 years that grows to $5 million off a $1 million investment as an example.
“You can make the election when you sell that fund, that that $4 million gain is completely tax free,” Neiffer says. “That’s the benefit of the opportunity zone.”
Neiffer says the limitations and potential of farmland in an opportunity zone is still being defined. Neiffer says an agricultural business being started in an opportunity zone passes the test because “you have to substantially improve the asset you buy if it’s real estate” and farmland is a bigger challenge for passing that.
“Opportunity zones are definitely still working out the details,” Neiffer says. “This law is now more than two years old [and] we just got final regulations.”
Neiffer says he expects an uptick in agricultural land meeting the requirements to opportunity zones in the next few years as familiarity with the regulations grows.
Specific states follow a set of rules different from the federal rules. To find the opportunity zones visit https://eig.org/opportunityzones and follow the map.
Read more: How to protect your farm and save money
Charitable Remainder Trust
Farmers in a position to retire in the near future could consider a charitable remainder trust. The goal of the trust is to reduce taxes by placing assets in it and then paying a beneficiary for a specific time period and upon expiration, the rest is given to charity.
Neiffer uses an example of a farmer retiring in 2020 with the 2019 crop to sell. The farmer has self-employment tax and also loses expenses because many are unnecessary after retirement, and the farmer gets pushed into a higher tax bracket.
“We can take that grain, take that farm equipment, and we can put it into what we call a charitable remainder trust,” Neiffer says. “We can have an annuity trust or a uni-trust, but the nice thing about it [is] we effectively sell our crop for cash and we spread the gain out over a five-, 10-, 15-, 20-year period or longer. We effectively get installment sale treatment on cash and we’ve eliminated the self-employment tax.”
Neiffer suggests avoiding a lifetime period in case of an accident or death soon after retirement that would limit the beneficiary’s received amount.
“I probably discuss with farmers at least three times a year – five times a year,” Neiffer says. “I would say for every 10 discussions I have, I get two farmers to do it.”
Neiffer says the feeling of having less control deters many farmers, but he says those involved may have more control than they think.
“In this case, the farmer is the donor, the farmer’s the beneficiary, the farmer can actually be the trustee,” Neiffer says. “So, the farmer is really still in control – but not in 100% control. Because the farmer can’t borrow from the [annuity trust], can’t loan money to the [annuity trust], can’t sell the farm equipment to the kids.”
Read more: More MFP coming soon to a farm near you
If estate taxes are a concern, offloading some of the value could save landowners in the long run.
One way to do this is through annual gifts, according to Neiffer. Each year there’s a $15,000 maximum for gifts to given to a donee, but a donor can give multiple gifts. So, you can give out multiple gifts, but you can only receive one per year. To take advantage of this annually, you also have to use it that year, and you can’t carry it over from a previous year.
“If you’ve got four kids and some grandkids, [it’s] pretty easy between a husband and a wife to generate annual gifting of $500,000,” Neiffer says.
Neiffer says land can be put into a limited liability entity, you can discount it by at least 35%, so the $15,000 can get a value of $25,000 to $30,000.