George and Martha Campbell currently own a 15-acre farm that has been in his family for generations. George inherited the farm 20 years ago when his father died. The farm is situated along a busy road, including a prime intersection in a small town in central New Jersey. Residential, multi-family, and office development have been very active in recent years, and the Campbells frequently receive solicitations from developers. The Campbells would like to pass the farm onto their children and grandchildren, and certainly want to see the family’s heritage preserved.
The Campbells are getting older and no longer have the energy to operate the farm in a manner that makes it self-sufficient. Getting up before sunrise and working until sunset or beyond has taken its toll on the Campbells. Planting the hay, maintaining the equipment, and then harvesting the hay is a business better suited for a younger couple. Fluctuations in the price of hay, along with the complete lack of cashflow for months at a time, only serve to exacerbate the problems the Campbells are facing. Mr. Campbell would prefer to pass the farm onto his children and grandchildren, and he certainly does not want to sell the property outright and pay hefty capital gains taxes.
Let’s assume that Mr. Campbell inherited the property 20 years ago, and the fair market value at the time was $1,000,000. It is anticipated that the value of the entire property in an outright sale would be more than $2,500,000. Without a 1031 exchange, the Campbells would be expecting to pay taxes as follows:
|Capital gains on the appreciation||($1,500,000 x 20%)||$300,000|
|Affordable Care Act tax||($1,500,000 x 3.8%)||$57,000|
|NJ State capital gains on the appreciation||($1,500,000 x 8.97%)||$134,550|
| || || |
|Total estimated tax owed|| ||$491,550|
The Solution: A Conservation Easement, Coupled with a 1031 Exchange into Delaware Statutory Trusts
The Campbells will sell a conservation easement, permanently restricting the use of the property to farm-related uses. They will be able to continue to farm as much or as little of the farm as they wish and may even convert to a less labor-intensive operation. The total sale price of the easement will be $2 million, and the Campbells will structure the sale as part of a Section 1031 tax-deferred exchange. They will trade equal or up in value, to fully benefit from Section 1031.
Upon the sale of the farm, the exchange proceeds were sent directly to the Campbells’ qualified intermediary (“QI”) to be held in escrow until the purchase of his replacement properties.
Within 45 days after the closing on the sale, the Campbells properly identified interests in a variety of Delaware Statutory Trusts. (More information about 1031 exchanges into DSTs) Closings on the various DSTs occurred over the next several weeks, well within 180 days of the sale of the relinquished property, utilizing the exchange proceeds held by the QI.
The Campbells have successfully completed a 1031 exchange from one labor intensive relinquished property into multiple passive replacement properties. They exchanged equal or up in value, using all their equity, fully deferring the anticipated capital gains taxes. The Campbell farm has now been preserved against future development, and the DSTs are generating passive income for the Campbells that exceeds their farm-related income.
Learn more about the step-by-step processes involved in completing a tax deferred exchange and review with your tax and legal advisors.