High Plains Journal, KS
02-20-07
1031 Proposal Detrimental to Farmers
By Chris Clayton, DTN Staff Reporter
OMAHA (DTN) -- Experts in the field of land sales say farmers, not speculative
land investors, would take the biggest hit under a Bush administration farm-bill
proposal that would ban anyone from receiving commodity payments for land
bought using a 1031 tax-deferred exchange.
Under the USDA plan, farmland would be barred from commodity programs such
as direct or counter-cyclical payments, as well as marketing-loan programs, if the
land was purchased in a 1031 property exchange. But a farmer who sells and
buys land not using a 1031 exchange also likely would be excluded from farm
programs because of potentially high capital gains from the land sale. In addition,
the USDA plan for 1031s doesn't specify if farmers could continue receiving
commodity payments if the land they rent is swapped through a tax-deferred
exchange. In parts of the Midwest, most of the land is farmed through rental
agreements.
"I kind of find it hard to understand why the USDA wants to change tax policy in
the farm bill," said Monty Meusch, a vice president of real-estate for Farmers
National Co. in Omaha.
Secretary of Agriculture Mike Johanns said the proposal was created after
repeatedly hearing farmers criticizing the 1031 tax break as a reason farmland
values were increasing so rapidly. Investors are willing to bid up land prices to
avoid the capital-gains tax from other real-estate sales.
"As we listen to farmers out there, the 1031 is really a burr in their saddles,"
Johanns said earlier this month at a cattlemen's convention.
The 1031 exchange provision in the tax code has been in law since 1921. It
allows people to sell commercial real estate then buy real estate of comparable
value without paying a capital-gains tax on the sale of the first property. The law
has been broadened over time to characterize all business real estate, whether
it's a high-rise building or farmland, as like-kind properties eligible for exchange.
"It was very popular to say 1031s are what was causing the run-up in land prices
over the last few years," said Mike Duffy, an Iowa State University extension
economist who tracks land values in Iowa.
Opponents of Johanns' plan for 1031s point out the connection with another
USDA proposal to cap farm payments for producers with adjusted gross incomes
of $200,000 or less. What happens if a farmer sold a piece of land and chose not
to use a 1031 exchange because the new ground then would be ineligible for
commodities? The increased income from the capital gain on the selling of the
old land could easily push a farmer's adjusted gross income high enough that
they would also be excluded from farm programs.
For instance, let's say a farmer bought 200 acres of land in 1998 at USDA's
national average land value of $1,340 an acre, or $268,000. Selling the 200
acres using USDA's 2006 average land value, $2,390 an acre, would amount to
a gross sale of $478,000 and a capital gain of $210,000. Even if the farmer had
no other income, his adjusted gross income would now be higher than USDA's
proposed income cap for farm payments.
"You are darned if you do, darned if you don't," said Dave Brown, president of
Iowa Property Exchange in Des Moines, who works exclusively on 1031 sales.
Duffy said other forces play a bigger role in land values, notably commodity
programs themselves. USDA's own charts showing the increase in land values
shows there was a 19-percent increase in farmland values from 1998 to 2002
nationwide. Land values have risen nearly 44 percent since the 2002 farm bill
went into effect with a broader array of safety-net programs than the previous
farm bill. Duffy estimates 45 percent of Iowa's land values are directly attributable
to commodity programs.
"The commodity programs have basically been incorporated into the values," he
said.
Earlier in the decade, farmers were finding competition for land from investors,
Duffy said. That largely was due to poor returns for other investments, such as
the stock market, which languished through recession. Land was considered one
of the few attractive options for investments.
Evidence suggests that investors have been a key factor in pushing up land
values. A newsletter last fall by a real-estate firm in Indiana and Illinois indicated
that there were fewer 1031 investors in the market now, but this group has been
"the backbone of the market the past several years, aggressively competing
against farmers to purchase land."
The Illinois Society of Professional Farm Managers and Appraisers stated at last
summer's Farm Progress show that a 30-percent increase in land values in
Illinois from 2004 to 2006 stemmed from urban growth around Chicago causing
people to sell land for development then buy farmland in more rural areas. The
Illinois survey indicated half of land purchases over the first six months of last
year involved a 1031 exchange, including an 826-acre tract near Bloomington,
Ill., that sold for a record $6,000 an acre.
Johanns isn't the only policymaker advocating restrictions on 1031 sales. Rep.
Collin Peterson, D-Minn., chairman of the House Agriculture Committee, also has
criticized 1031 exchanges for making it more lucrative to sell land to developers
than to fellow farmers. Peterson said farmers should only get a 1031 exemption
when they exchange farmland for farmland.
That's largely what happens now, farm managers and 1031 experts said. The
most common 1031 exchanges involving farm or ranch land come from farmers
selling along the outskirts of growing cities then buying land farther away from
the sprawl.
"They are able to replace the land they sell near the city with a larger tract
somewhere else," Meusch said.
Brown, who works with clients on the intricacies of the 1031 regulations, said
about 38 percent of his business in Iowa involves farm ground. About 17 percent
of those sales come from people selling commercial or development property
then buying farmland. The vast majority of transactions involving farmland
translate into farmland sales being exchanged for another farm, he said.
"Before we promote such changes, we need to understand that 1031s can be a
good thing for farmers," Brown said. "1031 is an exceptional tool and it is being
used by farmers."
Carl Johnson, an investment executive for Bethel Fisher & Co. near Des Moines,
helps property owners buy shares in commercial properties through like-kind
exchanges. He said such a restriction in farm programs would keep farmers from
expanding their operations. Farmers who sell land would look for other property
alternatives to protect them from capital gains if buying another farm is no longer
an attractive option.
"To a farmer who wants to wants to continue farming, I can't see how that
particular program will be beneficial," Johnson said. "It actually helps our
business because it deters the farmer from going to another farm property."
Chris Clayton can be reached at Chris.Clayton@dtn.com.