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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.
However, before investing in any new asset class, it is important to understand how the investment is taxed.
In this article, we will be explaining how most farmland investments are taxed as well as any tax benefits associated with farmland investing.
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.
These days, farmland investors frequently put a portion or all of their land in conservation trusts through this type of easement. They will reap 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.
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.
Other Farmland Tax Benefits
Outside of setting up a land conservation trust, here are other potential tax benefits associated with farmland investing.
1. Sales Or Property Tax Exemptions
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.
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.
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.
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.
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.
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.
4. 1031 Exchange
Farmland, like other real estate, qualifies for 1031 exchanges.
This allows you to defer capital gains tax by rolling the profits of one real estate investment into a like-kind investment.
For example, let's say you purchased a piece of farmland for $100,000 and you sold it 10 years later for $150,000. You would have $50,000 of capital gains to pay taxes on.
If you wanted to defer those taxes and pay them later, you could purchase another piece of farmland for $150,000. As long as you complete the exchange within the IRS timeline, you can say “catch you later” to the IRS when it comes to the taxes.
5. Individual Retirement Accounts
Not all assets are permitted to be owned in a retirement account, but real estate is allowed to be. An IRA is a type of investment account that allows you to invest with certain tax advantages. The two most common ones are the Traditional and Roth IRA.
With a Traditional IRA, you avoid taxes now but pay them later.
With a Roth IRA, you pay taxes now but avoid them later.
Individual IRAs give investors a lot more flexibility when it comes to what they are investing in. You are not solely limited to mutual funds or other funds like you are with most 401(k) plans.
Some of the platforms such as Harvest Returns allow you to invest through an IRA to reap these benefits. You simply have to fund an IRA account using one of their partners and direct those funds to one of the agricultural investments on their platform.
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 can earn 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.