Farmland investing taxes explained

Farmland Investing Taxes Explained 2021: What Are The Tax Benefits?

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For decades, farmland has proven itself to be a smart investment. Historically, it simply does not lose value, and has even outpaced the stock market.

Farmland is also an excellent choice for diversifying your portfolio.

Then there’s the satisfaction of knowing that, as an investor, you are helping preserve open spaces that might otherwise be slated for deforestation and land development. In other words, leveling trees and destroying natural pastures to build homes and offices.

Farmers are often inter-generational family members passing on traditions. And finally, farms are a sustainable, plant-based way to feed the explosive growth in world population.

However, as an investor, you are also looking for ways to increase your net worth. One of those ways is to take into account tax benefits, and when it comes to farmland, that list is also long.

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Conserving Farmland Through Trusts

There are nearly  920 million acres including 2.1 million farms and ranches across the country according to the USDA.

However, this represents a steep drop off from its peak in the 1930s, when there were more than 7 million farms.

Helping preserve the future of this land is vital for many reasons. One of them is that this can provide you with substantial tax benefits.

What Is A Land Conservation Trust?

Since the late 1800s, land trusts, also called conservation trusts, have been used to protect natural areas and productive land such as farms.

One of the ways to prevent farmland from urban sprawl is through land conservation trusts. This includes getting a conservation easement to limit the uses of the land both now and in the future.

Conservation purposes can include sheltering open spaces for parks, wildlife preserves or other natural habitats. Land easements are put in place to ensure the land is permanently protected. 

These days, farmland investors frequently put a portion or all of their land in conservation trusts through this type of easement. They will reap significant tax benefits but at the same time preserve the land and protect its future.

Conservation easements offer unique tax advantages for investors. They will benefit all the people in the community at large by permanently protecting natural resources. Because of this factor, investments can qualify as a charitable tax deduction on federal income tax returns.

How much of a tax deduction can you claim? The value of the conservation easement varies.  In most cases, the most valuable easements are found on areas of open space and farmland that has gone on the radar for future development based on its size and location.

Check with your tax professional to determine what percentage of the value of the farmland qualifies as itemized deductions. In some cases, you will be allowed a larger deduction in the first year you buy and establish a conservation trust than you will in subsequent years.

What If I Take Out A Loan To Finance Buying The Farmland?

All 50 states give preferential property tax rates to agricultural land in an effort to help farmers and slow down urban sprawl.

In order to get the most income tax breaks for farming, you have to prove to the Internal Revenue Ser­vice your farm is a valid business, as compared to it being a hobby. The IRS stipulates taxpayers are in business if they can show a profit in three years out of the most current five years.

Although it varies by state, in general any interest paid on loans to purchase farmland is deductible. The interest paid on farm mortgages and other farming-related loans is also deductible. 

There are also federal tax laws that apply to farming. You are considered to be in the farming business if you cultivate, operate, or manage a farm for profit, either as owner or tenant. The farmland may be used for growing and harvesting fruit, vegetables, dairy, livestock, poultry and fish.

What Are Other Property Tax Benefits Of A Farm?

States provide a wide array of tax benefits for farms, with the most common being exemptions from sales, use or property taxes.

A state may allow farms to avoid paying such taxes in the first place, or may issue a credit for taxes paid after farms have filed their returns each year.

Can I Use Depreciation In Value As A Write-off?

Depreciation is defined as the decline in the value of assets over their estimated useful lives.

Unfortunately, you can't deduct the overall cost of farmland because land does not wear out, become obsolete or get used up.

What Other Deductions Related To Farming Can I Claim?

Unlike the property itself, farm buildings can be written off over either 10 or 20 years, depending on what they’re used for. Land improvements such as drainage systems and soil enhancements can be depreciated over a 15-year period.

Most farm equipment will have a five-year life for tax purposes.  This is just a general rule and there are exceptions. Some farm assets such as fences around the farm property or storage bins for grain have seven-year lives when it comes to depreciation.

Land clearing expenses that prepare land for farming also eligible if you are converting grazing or pastureland to usable farmland.

If you make capital improvements on the land, such as buildings, livestock pens, or other necessary farm equipment, depreciation expenses on these items can be deducted from your gross income.

Farmers may generally deduct the cost of materials and supplies in the year in which they are purchased. This would include deducting the cost of fuel, tools, fertilizer and feed.

Farmers can also deduct most expenses associated with the repair and maintenance of the physical structures on the farm property. This would include deducting expenses for work such as repairing the roof of a farm building or putting up a new fence.

The cost of seeds and plants used to produce a crop for sale are also typical deductions.

There may be additional tax breaks on the horizon. Because of the unfortunate continued decline in farm profit margins, farmers and farmland investors will likely be requesting additional property tax relief.

Conclusion

Similar to other businesses, running a farm or owning farmland and renting it out is complex and involves many moving parts.

However, unlike many business endeavors, farming has an irreplaceable impact on the world at large.

Protecting theses properties is an enormous necessity, and farmers who establish conservation easements should and are awarded tax benefits.

Other write-offs for depreciation on farming equipment, making improvements on the site to physical structures, and the annual costs of seeds and fertilizers are also imperative for farmers to stay in business.

As time goes by and we see a decline in both the number of farms and their profit margins, there will hopefully be additional tax relief benefits to these caretakers of land and the investors who support them.

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