Written by Brett Visintainer
Home to three of the nation’s top agricultural producing counties, and as one of the country’s most productive farming regions, the Central Valley has a rich agricultural history. However, as the farming population’s demographics ages and the industry dynamics have shifted, many farmers are looking for diversification and exit options. With the majority of the farming family’s wealth land-locked, the biggest concern is losing generational wealth to capital gains taxes upon the sale of the land. One solution to this problem is employing Section 1031 of the Internal Revenue Code.
Section 1031 allows the commercial property owner — whether an individual, family or corporation — to defer the capital gains taxes earned from the sale of the asset when the proceeds are used to acquire “like-kind” property. This could potentially save you millions of dollars. However, the rules are complex, guided by strict timelines, and riddled with pitfalls.
In this article, I will explore how agriculturists can avoid the pitfalls of Section 1031, often referred to as a 1031 Exchange, and successfully defer their taxes by planning ahead, assembling the right team and following the strict timing requirements to save their family legacy and secure a better future for generations to come.
Establishing a game plan
As a former Dallas Cowboys kicker, I know the importance of establishing a solid game plan. Without a game plan, you’re likely to drop the ball. Your plan to execute a 1031 exchange will strategically guide you to the end zone and should include considerations for timing, your team, financing and the property type or types you want to exchange into. We will begin with the property type and financing and explore the timeline and team considerations in the following sections.
- Property Type
The type of properties you will want to acquire should be a function of several factors, including your risk profile and how much time you want to dedicate to managing your new acquisitions.
For example, if you are seeking to retire, have a preference for low-risk and minimum management, you may want to relinquish a portion or all of your farmland to acquire a portfolio of triple-net single-tenant retail properties.
If your risk tolerance is low-to-moderate and you are interested in acquiring property for you or your children to manage, a portfolio that includes multifamily buildings may be of interest.
By planning ahead, you will have a property or group of properties to get you into field goal range, and ready to move on as soon as you close on the sale of the asset you are relinquishing in Phase I. This phase is also often referred to as the “downleg.”
Financing is an important and valuable tool that could have a dramatic impact on your acquisitions. Although there are strict guidelines, there are a variety of ways you can approach an exchange.
It is essential to determine if you will use financing, for what property type and how much you will need on the front end so that you have a clear picture of the requirements, your loan options and other critical elements.
Trying to figure this out when you’re in the middle of a play makes it likely you’ll fumble. Planning ahead will allow you to fully explore all of your options to achieve the most beneficial outcome.
A winning team
Assembling the right team is essential for a successful closing. Your team will provide counsel in some cases, execute important elements on others, or both. The complexity and multiple moving parts, calls for experience and expertise in a variety of areas. The team members you will want to bring on board are a:
- — Commercial real estate broker
- —Commercial lender
- — CPA
- —Qualified Intermediary (QI)
The roles of the commercial lender, CPA, and attorney are likely very familiar to you, so we will focus on the commercial real estate broker and the qualified intermediary.
The commercial broker
Your commercial real estate broker will typically have two roles — one as your advisor and the other as your broker to execute the transaction.
In other words, coach and quarterback.
To begin, look for a selling broker that specializes in the type of investment properties that you want to sell and has experience in conducting 1031 exchanges. So, for example, if you want to sell agricultural property, it is important to speak with a broker that has experience, contacts, and expertise in selling ag properties. They will know who is doing what, who is buying, what is happening in that asset category and how to price your property. This will not only save days, it can save weeks and make a big difference in your timing. Their experience will be invaluable in dealing with the complexities of the options the exchange will present, the rules and the time restrictions.
In addition, brokers with category and investment experience will have developed extensive relationships with buyer’s reps, attorneys, lenders, qualified intermediators and other potential sellers. Relationships with other sellers are important because they can give you access to off-market deals or opportunities.
These relationships, investment expertise and category knowledge will be essential for Phase I because they will help set you up for success in the rest of the exchange.
The qualified intermediary
A qualified intermediary (QI), also known as an accommodator, has a unique role in an exchange. They are at the center of the action technically selling your property, collecting the proceeds from that sale and then using those funds to acquire your replacement property or properties. Despite their critical role, it is very important to note that the QI industry is not regulated and most states don’t even require they be licensed or bonded/insured. It is essential to conduct due diligence to ensure that the accommodator you will be working with is trustworthy, has a solid reputation, and has been in the industry for a while.
The 1031 stipulations have many guidelines and rules that can present potential pitfalls. For example, there’s the 200% rule, the 95% rule, and the three-property rule. However, the most important rule by which the transaction must be guided is the timing. This is the simplest requirement, but the one that causes the biggest challenges.
The first thing to understand is that there are two simultaneous timelines that get triggered on the day of the sale of your existing property.
- — The first one is that the seller must identify a replacement property within 45 days of the closing.
- — The second is that the exchange and all relevant transactions must be completed within 180 days.
While this seems simple enough, there is an array of potential stumbling blocks that can derail the process along the way.
As noted, the focus of the first 45 days is to identify a replacement property or properties. There are three rules you can employ to achieve this. These are:
- — The three-property rule, where you can identify up to three properties, one of which you have to acquire.
- — The 200% rule that allows you to identify an unlimited number of replacement properties, as long as their cumulative fair market value doesn’t exceed 200% of the fair market value of the relinquished property.
- —The 95% rule, which states that you can identify multiple replacement properties without consideration for their valuation, as long as the properties acquired amount to at least 95% of the fair market value of all identified properties.
Within 180 days of your sale date, you must close on all of the properties per the rule you’ve chosen.
When we’re working with clients, we open escrow right at the beginning of the 45-day period so if something comes up during due diligence, we have time to find a solution or even find replacement properties. We’ll often get calls from sellers who’ve already closed on their relinquished property and are days into their upleg, or Phase II. They are then feeling extreme pressure to figure things out in a rush, which can lead to an incomplete pass, or in this case, an incomplete exchange.
In a recent deal, we worked with a farming family in the Central Valley to sell one of their income-producing properties.
Employing a 1031 exchange, we used the proceeds to acquire four separate properties in multiple states outside California. The family deferred millions of dollars in capital gain taxes from a $25 million-plus sale by successfully completing the 1031 exchange. This allowed them to protect the wealth they had accumulated over the years from that asset while securing the future for their next generations.
With the volatility in the farming industry, changing generational preferences, and commercial property opportunities that exist today, a good game plan efficiently executed by the right team, can save you millions of dollars and ensure your generational wealth is preserved for the win.
Brett Visintainer is a former Fresno State and Dallas Cowboys kicker turned commercial investment real estate broker. Formed in 2018 and built on a foundation of investment real estate, the Visintainer Group is a client-first commercial real estate firm. Using a proprietary database of available properties, buyers, sellers and opportunities, they specialize in everything from commercial real estate transactions to multi-family properties, 1031 Exchange strategies, agricultural land, and full-stack investment services. The Group has executed over $300 million in transactions across the United States.