Agricultural landowners like you often ask us if raw land qualifies for the tax-deferral benefits of a 1031 exchange. The short answer is yes, but there are factors to consider, as with most investments.
The “like-kind” replacement property requirement of a 1031 exchange allows for most real estate properties to qualify, including raw land. Section 1031 of the Internal Revenue Code provides for the deferral of capital gains on the exchange of property held for productive use in a trade or business, or for investment purposes. The same holds true for a replacement property – it must also be held for productive use in a trade or business or for investment purposes.
It’s All About Intent
If you are using a 1031 exchange to sell your farm and are interested in exchanging it for raw land, your replacement property must be used for investment, trade, or business. Those purposes could include income from leasing activities or capital appreciation. Your raw land replacement property does not need to generate income to meet the “held for investment” requirement.
However, if you intend to make improvements and sell the raw land you acquire for a profit, a 1031 exchange would not be allowed. The Internal Revenue Service would deem this as an intent to sell rather than for investment or business purpose.
Raw Land to Build a Home?
Unfortunately, you cannot exchange raw land to build a primary residence. Property for personal use does not qualify for a 1031 exchange. However, if building a home or cabin on raw land is your goal, you may still be able to execute your exchange and partially defer capital gains tax.
One approach may be to purchase the raw land as your replacement property but exclude a small section of the property from your exchange for you to build a residence. This parcel of land would not be part of your exchange, and you would be responsible for purchasing it with non-exchange funds. But this approach may allow you to get the full tax-deferral benefit of your exchange while also building a house for your personal use. In any case, you should make sure to discuss such a scenario, and the specific facts of your purchase, with your tax advisor.
You know the value of owning land better than most which is why identifying raw land for your 1031 exchange replacement property might be a suitable option for you.
If you would like to discuss your situation with a financial professional experienced with 1031 exchanges, fill out the form on our contact us page. A representative will call you within 24-48 hours.
This communication is not intended as tax advice.
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