So you’ve finally done it, you have decided to sell the farm. Unfortunately, with a large sum of money heading towards your bank account, federal capital gains taxes are going to be applied. Depending on your annual salary, federal capital gains taxes can take up to 20% of the sale price from your farm.
In order to maximize your wealth, a 1031 exchange for mineral rights can be a go-to option. In this article, we will outline the steps on how to use a 1031 exchange to transform farms into mineral rights and royalties, completely tax-free.
How to Sell a Farm
First things first, you will have to sell the farm. There are a few ways to go about this. On one hand, you can try selling your farm by yourself. On the other hand, you can utilize a specialized broker or real estate agent to do all of the work for you (at a price, of course). As there is a considerable amount of work to be done, we strongly suggest working with a professional.
Determining the Value of the Farm
For most people, a farm includes most if not all of an individual’s assets. In order to determine the final sale price (and sales tax) associated with a farm, the property and everything it contains must be appraised. Most commonly, the sales price of farms in the United States is largely determined by:
- The Amount of Land
- # of Buildings and Size (Homes, barns, storage, etc.)
- Equipment (tractors, irrigation systems, bailers, etc.)
- Livestock (cows, horses, etc.)
- Supplies and Inventory (crops, fertilizer, etc.)
Taxes Paid on the Sale of a Farm
All in all, the sale of farmland can bring in a considerable amount of money. With that in mind, it is always going to be taxed in some form or another. Currently, the following taxes are applied to the sale of a farm in the United States:
- Federal Income Tax
- Recapturing of Depreciation
- State Taxes
- Federal Gains Tax
All in all, the amount of tax imposed on the sale of farmland can range anywhere from between 20% to 50% depending on all of the variable conditions. With this in mind, eliminating any of the taxation is a surefire way to save a bit of money during the sales process.
Using a 1031 Exchange on the Sale of a Farm
As we mentioned earlier, using a 1031 exchange is a great way to lower or eliminate capital gains taxes on the sale of a farm. A 1031 exchange can be used when another property is purchased that is similar to the farm. In buying a “like-kind” asset, former farm owners are not required to pay capital gains tax on the sale of their estate.
1031 Exchange For Mineral Rights – Requirements
In order to qualify for a reduction in capital gains tax with a 1031 exchange, the following timeline must be true:
- The same taxpayer sells and purchases both assets.
- New properties must be identified within 45 days of the sale of the farm.
- The new property must be purchased within 180 of the sale of the farm.
Of course, to qualify for a full elimination of capital gains tax, the new property must be of equal or greater value (i.e. trading up). Up to three properties can be identified as potential purchases regardless of their value. For more information on the rules and regulations for using a 1031 exchange, feel free to read our detailed page on the 1031 exchange process.
Like-Kind Properties for the Sale of a Farm
In order to use a 1031 exchange, the same taxpayer must purchase a new property that is similar to the old one. For the sale of a farm, there are many options within the realm of property that can be exchanged for, completely tax-free. Most commonly, farm sales are exchanged for:
- Better Farms
- A Home or Apartment
- Water and Ditch Rights
- Vacant Land
- Mineral Rights and Royalties
How to Purchase Mineral Rights and Royalties
More than anything, investments into mineral rights and royalties are a great way to reinvest the capital derived from the sale of a farm. Mineral rights entitle landowners to the valuable resources found below the earth’s surface. Mineral royalties are earned when those resources (such as coal, natural gas, or oil) are extracted and sold in the marketplace.
Using an Intermediary to 1031 Exchange Mineral Rights
In order to make sure the process goes as smoothly as possible, using an intermediary to 1031 exchange farm into mineral rights is the best way to go for. Utilizing the knowledge and resources of a licensed professional will not only help you save the most on taxes but will make the process easier along the way.
Ranger Land and Minerals has over 100 years of combined industry experience transforming assets into profitable mineral rights and royalties through 1031 exchanges. Our team of professionals is here to help leverage your farm for the best possible mineral rights and royalties.
Maximizing Return on Investment
Once you sell the farm, putting the money into something brand new such as mineral rights or royalties can be very intimidating. However, with the right purchase, your farmland very well may transform into a passive stream of income, profitable beyond any back-breaking labor tending to crops or livestock.
Purchasing Active Mineral Rights: With active mineral rights, cash flow is generated each month as mineral royalties are divided among stakeholders every single month. 1031 Exchanging for active mineral rights can lead to an immediate and ongoing income stream.
Purchasing Non-active Mineral Rights: Alternatively, mineral rights in high-production areas can also be profitable even if they are not currently being used by an oil or gas company. Non-active mineral rights can be bought and sold for profit, or retained through an oil and gas lease. Depending on your negotiation, new oil and gas leases can lead to steady income for years on end.
Ultimately, selling your farm is a tough decision. Once you’ve done it, however, your next step shouldn’t be so tough. Using a 1031 exchange to purchase mineral rights or royalties is a great way to reinvest your money without having to pay a capital gains tax. With the right purchase, mineral rights can be a very valuable asset in any portfolio.