Selling Ag Land in an Entity: Ownership Structures
Many farms and ranches are owned inside entities with multiple partners or shareholders. Upon sale, if some individuals want to do a 1031 exchange and others do not, proactive planning is necessary.
With limited exceptions, 1031 exchange rules require that the taxpayer or entity selling the relinquished property be the same taxpayer or entity acquiring the replacement property. However, with appropriate advance planning, there are strategies that can enable each member/shareholder to accomplish their goals. Those strategies differ based on the type of entity in which the ranch is held, such as a partnership, LLC, S Corp or C Corp.
Partnerships and Limited Liability Companies (LLCs)
Members of LLCs and partners have options for accomplishing divergent goals, depending upon how far in advance of the sale they have planned.
- Drop and Swap: Well before the sale, the partnership or LLC could deed the property out of the entity and into the individual partners’ names, who would hold it as tenants-in-common. Each individual would then be able to choose whether to take cash or complete a 1031 exchange. However, the timing of this strategy is critical – deeding the property should be completed long before the property sale or the IRS could disallow your 1031 exchange.
Swap and Drop: If there is not enough time prior to the property sale to safely complete a Drop and Swap, the partners/members may consider a Swap and Drop. This strategy works well if all partners/members want to exchange into other properties, but separate from each other. In a Swap and Drop, the individual partners select the property(s) they each wish to exchange into. The partnership would close the sale of the relinquished property and complete the exchange into the identified replacement properties. The partnership would then own these properties for a reasonable period of time, later deeding each property to the respective partner who had selected it.
It’s possible that deeding the real estate out of the partnership or LLC could trigger a taxable event. You should consult your tax advisor before implementing either of these strategies. For further information please refer to our Straight Talk guide, "Entity Planning When Selling a Farm or Ranch: Partnerships, LLC's and the 1031 Exchange."
Unlike partnerships and LLCs, shareholders of a corporation cannot get appreciated real estate out of the corporation without triggering a taxable event -- which effectively eliminates the ‘Drop and Swap’ and ‘Swap and Drop’ strategies for them. The corporation must be the entity to complete the exchange.
Further adding insult to injury, if the property is held in a C corporation, the sale may result in two levels of tax: one at the corporate level for the gain on the sale and one at the individual level for the distribution of profits to the shareholders. A potential solution for this problem is converting the C corporation to an S corporation, because an S corporation is generally not a separate taxable entity. For further information on corporate ownership of real estate, please refer to our Straight Talk guide, "Entity Planning When Selling a Farm or Ranch: Corporations and the 1031 Exchange."
We've provided the information above for general educational purposes only. It is not intended as specific tax or legal advice. Please consult your tax advisor for specific advice regarding your particular situation.