Arkansas Land Conservation Assistance Network

The 1031 exchange, as it is commonly known, derives its name from the section of the Internal Revenue Code which explains the use of a tax deferred exchange. Through this code section, a taxpayer is allowed to defer capital gain tax on the sale and subsequent purchase of investment or business property if the transaction is structured correctly with the use of a qualified intermediary (QI).

A taxpayer will enter into an exchange agreement with the QI who then works with the taxpayer to make sure the transactions are structured to meet all of the requirements of the IRS code.

The 1031 exchange process needs to start prior to the sale of your relinquished property. The QI works with your title company to make sure the sale of your property is handled correctly to accommodate your 1031 exchange. The intermediary will have some exchange documents for you to sign at closing. Then the proceeds from the sale of your property are sent directly to us, the QI (the taxpayer cannot have constructive receipt of the proceeds or it will nullify the exchange). The proceeds are deposited into a bank for the benefit of the taxpayer where they will stay until the closing of any replacement property.

The taxpayer will have 45 days from the date of closing on the sale (relinquished) property to identify any potential replacement properties they may want to purchase. The taxpayer has an additional 135 days to actually close on the purchase of the replacement properties. The intermediary will have some additional documents for the taxpayer to sign at the closing of the replacement properties. The intermediary will forward the necessary proceeds for the purchase of the replacement properties to the title company from your exchange account.

The most traditional tool for conserving private land, a “conservation easement” (also known as a conservation restriction) is a legal agreement between a landowner and a land trust or government agency that permanently limits uses of the land in order to protect its conservation values. It allows landowners to continue to own and use their land, and they can also sell it or pass it on to heirs.

When you donate a conservation easement to a land trust, you give up some of the rights associated with the land. For example, you might give up the right to build additional structures, while retaining the right to grow crops. Future owners also will be bound by the easement’s terms. The land trust is responsible for making sure the easement’s terms are followed. This is managed through “stewardship” by the land trust.

Conservation easements offer great flexibility. An easement on property containing rare wildlife habitat might prohibit any development, for example, while an easement on a farm might allow continued farming and the addition of agricultural structures. An easement may apply to all or a portion of the property, and need not require public access.

Qualifying for a Tax Deduction

A landowner sometimes sells a conservation easement, but usually easements are donated to a land trust. If the donation benefits the public by permanently protecting important conservation resources, and meets other federal tax code requirements, it can qualify as a tax-deductible charitable donation. Easement values vary greatly; in general, the highest easement values result from very restrictive conservation easements on tracts of developable open space under intense development pressure. In some jurisdictions, placing an easement on your property may also result in property tax savings.

Reducing Estate Taxes

Perhaps the most important benefit, a conservation easement can be essential for passing undeveloped land on to the next generation. By removing the land’s development potential, the easement typically lowers the property’s market value, which in turn lowers potential estate tax. Whether the easement is donated during life or by will, it can make a critical difference in one’s heirs’ ability to keep the land intact.

Having a well thought-out plan for who will own your land and how it will be managed after your death ensures that it will be successfully transferred to future generations without being sold or developed. It can also eliminate any tax liability.

Things to Consider:

• Working landscapes tend to be land rich and cash poor. Without fluid assets in your estate, your heirs may have a hard time paying estate taxes and have to sell part of the land. Consider using estate planning techniques to eliminate estate taxes or provide funds for estate taxes to ensure your land remains whole.
• What will the transition of ownership and management look like? An estate plan can also be a framework for transitioning ownership or management of your land. Consider whether you would like to transfer ownership and management responsibilities gradually to your heirs while you are alive or at your death.
• Fair is not always equal. If you leave your estate in equal portions to multiple heirs they may have problems agreeing on how to split it up. It may be the case that only one heir would like to continue managing the land, but he or she may not be able to buy out other heirs. This could result in the land being sold for development or a court ordered partition.

Tools to Eliminate Federal Gift and Estate Taxes

You can transfer your property to your heirs while you are alive (as gifts) or upon your death (as your estate). Both of these kinds of transfers may require that you pay taxes. However, if you create a plan to transfer your property in amounts that are less than the gift tax exclusion amount or the estate tax exclusion amount you may not be subject to federal taxes.

Another estate planning tool is to place a conservation easement on your land. A conservation easement will reduce the value of your land, because it eliminates valuable development rights, and ensure that your land remains whole for generations to come. If you qualify under IRS rules, your estate can also elect to take a estate tax deduction for 40% of the value of the land subject to the conservation easement.

Estate Planning Tools

You may consider creating a business entity under which your land will be owned and managed. As a Limited Liability Company or Family Limited Partnership, your land can be owned by multiple people and managed by just one. It will also ensure that the land and business remains a whole entity, with heirs participating in the way that they wish.

Another estate planning tool is a trust. There are a variety of different trusts, such as a Grantor Retained Annuity Trust or Charitable Remainder Trust that allow you to determine the management of your land after it has been transferred to your heirs. In addition, trusts can reduce gift and estate taxes.

If you do not have an heir interested in taking over your family farm, then you might consider finding a beginning farmer that does. There is a wide array of programs across the country that link retiring farmers with beginning farmers to keep land agricultural.

Finally, to increase the fluid assets in your estate or ensure the heirs not taking part in owning or managing the land are also provided for in your estate plan, consider taking out life insurance or a mortgage on the land.

Create your Land Legacy

Creating an estate plan is about more than just reducing tax liability, it is vital to ensuring that your land legacy continues for generations to come. It is important that you set up your heirs for success by using tax and estate planning tools that create a framework for the future management of your land.

By taking advantage of tax credits and deductions you can ensure the financial stability of your land for generations to come.

Property Tax Appraisal
The first thing that you should consider to lower your taxes is to apply for a timber/forest land appraisal. By having your property value assessed at the value in which it is used, rather than the highest possible use value, you can reduce the amount of taxes you pay on your land.

Federal Tax Issues
You can read more about federal tax issues associated with farmland here and forest/timber land here. Consider using different tax tools, such as wildlife habitat deductions, alternative energy credits, or section 179 deductions when purchasing new equipment.

Conservation Easements
Arkansas has also authorized conservation easements within the state. A conservation easement is a deeded restriction that prevents development and subdivision of your land. It also can contain provisions requiring that your land be managed for a conservation purpose, such as open space, wildlife habitat, or historic preservation. If you donate a conservation easement on your land you may be eligible for a charitable deduction on your federal income tax. You can read more about conservation easements in the Tax & Estate Planning Articles section on this website.