What is a 1031 Tax-Deferred Exchange you may ask?  An IRC 1031 Exchange permits you to sell property without paying tax on the gain of the sale, if you replace the property by following the rules.  Simply, a 1031 Tax-Deferred Exchange is the process of deferring the payment of taxes when selling investment property to a later time by investing the proceeds from the sale of one investment property into the purchase of another.

The 1031 exchange offers a pwerful tax deferral strategy for those selling farms and ranches.  This provision allows property owners in the agriculture sector to defer capital gains taxes by reinvesting the proceeds from a sale into so called “like kind” real estate.  Texas is experiencing growth like never before and much of what is now farm or ranch land is disappearing.  If you or your family owns farm or ranch land, you may want to take advantage of this tax deferral tool.

No type of real estate in America has more expansive possibilities for dererring capital gains taxes than agricultural land.  Whether you are buying more farmland, purchasing rentals or vacation homes, or acquiring hassle free passive real estate, the possibilities are numerous.  Much more than most people think.

Understanding the broad definition of like kind properties can significantly benefit sellers.  The misconception that exchanges must be between identical types of properties (e.g., farm for farm) limits many from exploring how this tax strategy can facilitate growth, creat diversification and increase cash flow, all without incurring immediate tax liability.  The definition of “like kind” property is very broad; it includes water and mineral rights, conservation easements, and even different types of commercial or residential real estate, creating a myriad of strategic investment opportunities. Additionally, leveraging Section 1031 in combination with Section 121 for the sale of a primary residence on the proprety can optimize tax savings, allowing sellers to maximize their financial outcomes.

The options for rural land owners are so varied that I can’t cover them in this one column.  So, I will focus only on the split treatment transaction this week.

A split treatment transaction involves the sale of a property used partially as a primary residence and partially for other purposes.  The landowner, in consultation with a tax advisor, must allocate the portion of the sales proceeds attributable to the part of the property that is used as a principal residence for tax exclusion under Section 121.  The remaining farm or ranch proceeds usually qualifty for Section 1031 deferral.  When closing on the sale, the landowner may receive the net sales proceeds allocated to the primary residence directly from the title company.  Before the sale closes, a 1031 exchange company (like Greg Lehrmann’s firm) acts as the qualified intermediary and must be in place for the business or investment portion of the transaction.  The landowner must meet other requirements also necessary for a 1031 Exchange.

An example: John and Mary have owned a 200 acre working ranch for 50 years and have always lived on the property.  Their tax advisor has allocated one acre as there primary residence.  The property is sold to a buyer.  John and Mary receive the portion of the sale proceeds attributed to the primary residence (net of the pro rata portion of closing costs) at the closing.  They then sign exchange documents for the remainder of the proceeds to go into their exchange account with the qualified intermediary.  Then through the qualified intermediary, they reinvest these proceeds into like kind property that has been identified for this purpose.  Thus, deferring taxes on those sale proceeds.

For sellers of agricultural properties, understanding and utilizing 1031 exchanges can lead to significant tax advantages and financila growth.  The inclusion of Section 121 provides an added benefit for those selling a primary residence, further minimizing the tax burden.  In essence, a strategic approach to selling agricultural property through a 1031 exchange can transform a simple sale into a substantial investment opportunity, ensuring long term benefits and financial security.

As many are aware, there are other opportunities with traditionally agricultural land.  Solar and wind fields have become popular, but there is growing evidence of economical damages caused by these options.  In future weeks, I will dicuss conservation easements, carbon credits, and other alternatives that can allow the property to still be used as the family traditionally has used it and still produce income.

Few buyers have property to trade, and not all sellers have located suitable replacement property when they’ve decided to sell.  That is when a real estate attorney and a title insurance company experienced in facilitating exchanges can be of assistance.

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As we approach the end of the year, it is time to remind folks of the Biden Administration’s Sensible Taxation and Equity Promotion (STEP) Act.  This makes a significant change to the Federal Estate Tax set to go in place January 1, 2026. Which means, the Estate Tax is Changing.

Right now under current law, there is a lifetime exemption of $12.9 million for a single person and $25.8 million for a couple.  This means if the gross estate value is less than the lifetime exemption, no tax would be owed.  However, the STEP Act lowers the Federal estate tax exemption to $5 million per person and $10 million per couple.

If you own a business, real estate or a farm or ranch, this will likely effect your estate.  When you consider the value of a business, real estate, house, equipment, investment or savings accounts, vehicles and cattle, it does not take long to reach $5 million.

The use of marital deduction trust clauses will become the norm for documents with those families with substantial assets as I have described.  These trusts were commonly used in 2001 and earlier when the Federal Estate Tax limit was $600,000.00.

Another planning tool is that you gift some of your cash into a trust that purchases a life insurance policy on you, a parent, or a grandparent. That policy is owned by the trust and at death the policy pays into the trust—at a rate of two to ten times the size of the original gift. TAX-FREE. Zero tax. Yes, not one penny to Uncle Sam. In fact, that would leave your family with enough to pay the estate tax and give generously to charities and foundations that you love as well as provide additional resources for your loved ones.

That’s a MASSIVE tax-free gift, isn’t it?

Now, even if you don’t have a $5 million estate, you may have assets that will grow enough that it makes sense to gift them out of your estate while the exemption amount is so high. Even moderate gifts can become extremely valuable inside a tax-free vehicle.

Yes, the Estate Tax is Changing, Talking to a Professional Can Help

But you won’t know unless you talk to a professional who can guide you and help you formulate a strategy to take advantage of this window—a window that’s getting narrower by the day. To help you get the insight and planning you need to help you take advantage of this perfect tax storm, please come and see us now, because planning can take time and there are only six and a half months left before the window is scheduled to close.

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By taking advantage of these gift options, you can support and contribute to the well-being and education of your loved ones without worrying about any tax implications.

Annual Exclusion Gifts

These are simply gifts of money or property that fall below a certain value.  For the year 2023, the value is set at $17,000 per person.  So you can give up to $17,000 to as many people as you want without having to worry about gift taxes.  If you’re married, you and your spouse can even double the advantage and gift up to $34,000.

The good news is that the IRS doesn’t consider these gifts as taxable, meaning you don’t have to report them on your federal gift tax return.

However, if your gifts exceed the annual exclusion amount or don’t meet the requirements, you may need to file a gift tax return.  There are also special situations where you need to file a gift tax return, so consult with an estate planning attorney to be sure.

Medical Exclusion Gifts

Paying for someone’s medical expenses directly to the provider or insurance company can quality for medical exclusion.  The IRS doesn’t consider these payments as gifts for gift tax purposes. This means that in 2023, if you pay for your grandchild’s medical expenses, you can still give them an additional $17,000 without having to worry about filing any gift tax returns.

The types of medical expenses that qualify for this exclusion are generally the same ones that can be deducted for federal income tax purposes.

Also, take note of these important requirements:

Pay the person or institution that provided the medical care directly.  Otherwise, the payment will be seen as a gift to that individual and not as payment for a qualified medical expense.

The amount you pay must not have already been reimbursed by the individual’s insurance company.  If any portion of the expense has been reimbursed, that reimbursed amount is not eligible for the unlimited medical exclusion from the gift tax.  Instead, it will be treated as if it was given on the date the individual received the reimbursement.

Educational Exclusion Gifts

Similar to the medical exclusion gift , paying for someone’s educational expenses, such as their college tuition, qualifies for the education exclusion.  The IRS does not consider it to be a gift for gift tax purposes.

For the payment to qualify, you also needs to meet 2 critical requirement:

Pay the institution providing the education rather than to the individual receiving the education.

The payment must be for tuition only.  It does not apply to miscellaneous expenses such as dormitory fees, books, and other similar education-related expenses.

Minimize the Impact on your Tax Liability

Providing financial assistance through these gift options can help you care for your family and minimize tax liability.  If you have any inquiries regarding the process of giving monetary or property gifts to your family, please do not hesitate to contact your estate planning attorney or tax consultant.

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 The information in this column is not intended as legal advice but to provide a general understanding of the law.  Any readers with a legal problem, including those whose questions are addressed here, should consult an attorney for advice on their particular circumstances.

At the eleventh hour, Congress averted the tax side of the ominous “Fiscal Cliff” that it faced as 2012 drew to a close. The end result of the intense negotiations was the American Taxpayer Relief Act of 2012 (ATRA).

 The most publicized part of ATRA prevented scheduled federal tax rate hikes from going into effect for most taxpayers in 2013, while raising taxes on America’s highest earners. ATRA also keeps in place many expiring income tax breaks and revives some tax increases that had expired over the past several years.

 Individual Tax Rates

For tax years beginning after 2012, ATRA makes permanent almost all of the federal income tax rates first put into place in 2001. Those rates otherwise would have increased in 2013. For high-income taxpayers, a new top tax rate of 39.6%, as opposed to the previous 35%, applies beginning for tax years after 2012.

 The new 39.6% rate applies to taxable income above a specified threshold (subject to future adjustments for inflation): $450,000 for married taxpayers filing jointly, $425,000 for heads of households, $400,000 for single taxpayers, and $225,000 for married taxpayers filing separately. The rate schedule is graduated, so taxpayers whose income falls within the 39.6% rate bracket still benefit from the extension of the Bush-era rates in the lower rate brackets.

 Capital Gains and Dividends

In recent years, individual and other noncorporate taxpayers have benefited from a maximum rate of 15% on net capital gains (net long-term capital gains minus net short-term capital losses). To the extent the net capital gains would have been taxed at the 10% or 15% tax rate if they had been ordinary income like wages, the net capital gains tax rate has been 0%.

 These net capital gains rates for noncorporate taxpayers had been scheduled to be replaced after 2012 by rates up to 20%. ATRA operates to make the 2012 net capital gains rates of 0% and 15% permanent for most taxpayers. A new 20% maximum net capital gains rate applies to taxpayers whose income exceeds the levels mentioned above concerning the 39.6% income tax rate.

 In 2012, qualified dividends from domestic corporations and certain foreign corporations were subject to the same maximum rates as net capital gains in 2012 (15% for most taxpayers, 0% if the income would otherwise be taxed in the 10%- or 15%-income tax brackets). These dividends were to have been taxed as ordinary income starting in 2013, resulting in substantially higher taxes, but ATRA intervened to retain the 2012 dividend rates of 15% and 0% for most taxpayers. As with capital gains, higher income taxpayers whose income exceeds the thresholds set for the 39.6% income tax rate now have a maximum rate of 20% on qualified dividends.

 Personal Exemption Phaseout and Limitation of Itemized Deductions

Before 2010, the personal exemptions available to higher income taxpayers were gradually reduced when their adjusted gross income (AGI) exceeded a specific threshold amount. Those higher income individuals also had their allowable itemized tax deductions for the year reduced by up to 80%. By law, the personal exemption phaseout and itemized deduction limitation were gradually reduced, until they were completely removed in 2010. The exemption phaseout and deduction limitation were set to return in 2013. ATRA revives them, at higher threshold levels than had been in place. The end result is that the personal exemption phaseout and itemized deduction limitation will likely affect many more people than just those in the new 39.6% top tax bracket.

 ATRA also includes extensions of a variety of individual tax benefits that either expired at the end of 2011 or would have at the end of 2012. Just a few examples of these many benefits are the Child Tax Credit, the State and Local Sales Tax Deduction, the Earned Income Credit, the Coverdell Education Savings Accounts, IRA Distributions to Charities (by persons aged 70^1/2 or older), and the Energy Credit.

 Estate and Gift Tax

For 2012, the maximum federal estate-tax rate was 35%, with an exclusion amount of $5.12 million ($5 million indexed for inflation) that shelters an aggregate amount of transfers at death and lifetime gifts from estate and gift tax. But for ATRA, this top rate and exclusion amount were set to expire after 2012, resulting in a highest tax rate of 55% and an exclusion amount of only $1 million (not indexed for inflation).

 ATRA permanently sets the top federal estate tax and gift tax at 40% with an exclusion of $5 million (inflation adjusted) for decedents dying and gifts made after 2012. ATRA also permanently allows “portability” of a decedent’s unused exclusion between spouses.

 Included among the other parts of ATRA are provisions that extend the estate-tax deduction for state estate taxes, qualified conservation easements, and the installment payment of estate tax on closely held businesses. ATRA repeals the 5% surtax on estates larger than $10 million.

 This article merely to update you on the recent changes in our Federal Tax Code.  Estate planning techniques and tax laws are complex.  You should always consult with a qualified attorney to assist you in such matters.

 Sam A. Moak is an attorney with the Huntsville law firm of Moak & Moak, P.C.  He is licensed to practice in all fields of law by the Supreme Court of Texas, is a Member of the State Bar College, and is a member of the Real Estate, Probate and Trust Law Section of the State Bar of Texas.

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