By Dan Wagner, senior vice president of government relations at the Inland Real Estate Group and member of the board of directors of the Conservation Foundation
We don’t inherit the earth from our ancestors, we borrow it from our children. –Native American proverb
As the proverb suggests, land conservation and farming are inextricably connected, because those who make their living from the land are also stewards of the land charged with protecting it for future generations. The 1031 like-kind exchange is an important financial tool and incentive that farm and conservation communities can utilize to achieve their shared goals.
Under section 1031 of the U.S. tax code, like-kind exchanges allow real estate owners to reinvest their gains from the sale of income-producing properties into a similar, or like-kind, property while deferring the capital gains taxes in the process. In the future, when the owner of the land eventually liquidates the investment, the government collects its rightfully due taxes.
Land Conservation Utilizing the 1031 Like-Kind Exchange
One of the major initiatives for the land conservation community is to protect 30% of our nation’s land by 2030 (also known as “30×30” in the conservation community). The use of the 1031 like-kind exchange by land owners is a tool to help achieve this goal.
Land conservation organizations rely on like-kind exchanges to preserve open spaces for public use or environmental protection. Land conservation transactions often involve the exchange of environmentally sensitive areas for less sensitive, privately-held properties or the offer of conservation easements. Typically, the property that will be subject to the conservation easement is first appraised to determine its current fair market value as unencumbered land. Then a secondary, encumbered value is determined by taking into account the future limitations on development and other land use under the easement. The value of the easement is the difference between the unencumbered and encumbered valuations. The landowner may be able to elect to 1) receive a tax deduction for the contribution of the easement, or 2) be paid the value of the easement.
A landowner electing to be paid for a permanent conservation easement can use those proceeds to acquire replacement property through a 1031 like-kind exchange.
The following are some examples of how land conservation organizations have utilized the 1031 like-kind exchange to preserve and protect our nation’s environment:
Rookery Bay National Estuarine Research Reserve in Florida
The Reserve is described as a 110,000-acre parcel of pristine uplands, mangrove forest that includes the protected waters of Rookery Bay. The reserve stretches from Gordon Pass in Naples, Florida, to the western Everglades. The reserve had no public access except for an 80-acre parcel that was owned by a developer. Thanks to a 1031 exchange, the developer was able to sell that land to conservation groups so they could have access to this amazing, pristine ecosystem; meanwhile, the developer was able to get a new, similar parcel elsewhere for their development.
Mississippi River Watershed
Nutrient discharge from agricultural watersheds along the Mississippi River has resulted in a large dead zone in the Gulf of Mexico. As a result, farmers are using the 1031 like-kind exchange to get permanent conservation easements so as to take environmentally sensitive farm fields out of production and preserve the land. Given the need to maintain the value of their investments and derive comparable income from a replacement parcel of farmland, the farmer is incentivized to make the exchange by using pretax dollars.
Grassland Reserve Program in Idaho
A large grazing association in Southeastern Idaho was approached by the National Resources Conservation Service about offering a Grassland Reserve Program easement to the USDA for some grazing land. The goal was to limit further development and preserve the native grasslands for wildlife habitat. By using the 1031 like-kind exchange, the association was able to acquire other, less environmentally sensitive land, thus protecting important natural resources.
Protection of South Boulder Creek Watershed in Colorado
Through public and private funding, over 3,300 acres were permanently put into a conservation easement thanks to the 1031 like-kind-exchange. The easement protects critical drinking water sources for Boulder and Denver, improves forest management and safety, and sustains and enhances recreational opportunities.
Farmers and Ranchers Utilizing the 1031 Like-Kind Exchange
Farmers and ranchers use 1031 like-kind exchanges to combine acreage, acquire higher-grade lands or improve the quality of their operations. They use like-kind exchanges to reconfigure their businesses so that young or beginning farmers can join in the business. Retiring farmers are able to exchange their farm or ranch for other real estate to provide ongoing retirement income.
The family farm has played an important role in U.S. history and remains a cornerstone of American culture. The following examples provide insight into the importance of how the 1031 like-kind exchange is a key tool for protecting the family farm:
Homebuilder Acquires Farm
A farmer’s land was on the outskirts of town, and a homebuilder saw an opportunity to build homes for the local town’s growing population. The farmer was able to sell the homebuilder the land and use the 1031 like-kind exchange to acquire new land for farming elsewhere. The farmer is able to move the operation to an area that is not hemmed in or subject to nuisance regulations. Many jobs were created through the homes being built, and the town was able to provide more affordable housing for its citizens.
A farmer owned two 80-acre tracts located 20 miles away from his home operation. The farmer’s neighbor listed for sale a 160-acre parcel of land next to their home farm. Through a 1031 like-kind exchange, the farmer was able to divest the two distantly located 80-acre parcels, acquire the neighbor’s 160-acre tract and combine those land holdings into a larger farm of 360 acres.
Keeping the Farm/Ranch in the Family
A 65-year-old farmer owned an 80-acre farm that had been in the family for decades. When the land was first purchased, land prices were much lower. The farmer’s son was a beginning farmer and wanted to acquire the ancestral land. However, the potential tax liability made the farmer hesitant to sell the land to his son at a reasonable price. With a like-kind exchange, the farmer’s son was able to purchase the land and keep it in family ownership, while the father was able to acquire other income-producing property investments.
A farming couple owned 1,000 acres of farmland, but none of their three adult children was interested in taking over the family business. So, mom and dad used the 1031 tax code provision to exchange their land for rental apartment buildings to help provide the income they needed for their retirement.
These simple, real-world examples illustrate how effective section 1031 like-kind exchanges are for land conservation and farming. The prospects of the land conservation initiative to save 30% of the country’s land by 2030 and the future of the family farm in the U.S. are clearly dependent on keeping the section 1031 like-kind exchange in the tax code. Periodically, the like-kind exchange is viewed by some politicians as an unwarranted tax loophole that ought to be repealed. Last year, President Biden’s campaign suggested this. The land conservation and farming communities need to come together and let Congress know how vital the like-kind exchange is to the future of our land and that it must continue.