Selling farmland can yield considerable profits, but also involves navigating complex capital gains tax rules. For families that have owned rural agricultural property for generations or investors seeking to benefit from increasing land values, understanding the tax implications is key.
This comprehensive guide provides clarity on how capital gains taxes apply to selling farmland, special exemptions you may qualify for, planning strategies to minimize tax liability, factors around inherited property, and answers to other common questions.
How Are Capital Gains on Agriculatural Land Calculated?
When selling farmland at a profit, capital gains taxes apply to the increase in value or difference between the sale price and the original purchase price, referred to as the cost basis. Several factors impact how much tax you’ll owe:
- Length of ownership – Tax rates differ for short-term (owned 1 year or less) versus long-term capital assets (owned over 1 year).
- Original purchase price & sale price – The difference between these two amounts determines your capital gains.
- Improvements – Increasing the tax basis by including investment in improvements over the years you owned the land.
- Selling expenses – Reducing your capital gains by including expenses incurred selling the land.
In 2023, federal tax rates on long-term capital gains from selling land are either 0%, 15% or 20% depending on your overall income and tax bracket. State taxes may also apply.
Read More: Capital Gains Tax on Home Sales in the USA
Special Capital Gains Exemptions for Farmland
Selling rural land used for agriculture may qualify you for special capital gains tax exemptions at the federal or state level:
Section 121 Exclusion
Also called the home sale exclusion, Section 121 exempts up to $500,000 in capital gains from land sales if:
- You or immediate family owned and lived on the property for 2 of last 5 years.
- The land is zoned rural or agricultural.
- Land use meets Section 121 requirements outlined by the IRS.
Married couples can exclude up to $1 million in capital gains using this exemption.
State Exemptions
Some states offer full or partial exemptions from capital gains taxes on the sale of agricultural land if specific requirements are met, such as:
- Required ownership period, such as 5 years out of last 10 years.
- Inherited farmland sold within x years.
- Size threshold for land parcel.
Check with your state’s department of taxation to learn about exemptions available where your rural land is located.
Read More: Capital Gains Tax on Real Estate: A Detailed Guide
How Can I Minimize Capital Gains Taxes When Selling Land?
If no special exemptions apply to your farmland sale, here are some tips to minimize owed capital gains taxes:
Increase Cost Basis
Any investments or improvements made during your ownership of the agricultural land can increase the cost basis and lower eventual capital gains:
- Keep detailed records of any money spent on upgrades like irrigation systems, fences, barns, soil enhancement, etc.
- Factor carryover basis into inherited land value.
Donate Easement
Permanently surrendering development rights to a qualified land trust lowers the land’s assessed value, resulting in lower capital gains when sold. Additional tax deductions are also possible.
Offset Gains
If you have other investment losses the same tax year, they can offset capital gains from selling your agricultural land holdings and lower overall tax liability.
Spread Out Sales
Structuring the farmland sale over 2-3 tax years evens out capital gains and may lower total taxes owed compared to a lump sum payment. This works best when selling to a family member.
Deferred Payment Installment Sale
Selling the land in exchange for a private mortgage with the balance due over time allows for capital gains tax payments to also be distributed over several years.
Read More: Capital Gains Tax on Home Sales in Colorado
What About Inherited Farmland?
Inheriting agricultural property comes with its own unique tax considerations when it eventually gets sold by heirs:
- Step up basis – Cost basis steps up to current FMV on date of death, minimizing capital gains.
- 2-3 year ownership period – Many states have exemptions if inherited land sold within 2-3 years.
- 1031 exchange – Heirs can exchange inherited land for another like-kind agricultural property and defer capital gains taxes.
Consult a tax professional specializing in farmland succession planning to ensure you utilize all available exemptions and properly report inherited property sales.
Table 1 summarizes the capital gains exemptions and tax minimization strategies covered in this guide:
Table 1. Summary of Capital Gains Exemptions & Minimization Strategies
| Exemption / Strategy | Description |
|---|---|
| Section 121 Exclusion | Up to $500K exemption for land owned/lived on 2 of last 5 years |
| State Exemptions | Varies – consult state department of taxation |
| Increase Cost Basis | Investments/improvements made during ownership lower taxable capital gains |
| Donate Easement | Surrendering development rights lowers assessed land value and owed taxes |
| Offset Gains | Use investment losses to offset land sale capital gains |
| Spread Out Sales | Structure sale over 2-3 years to lower yearly tax liability |
| Deferred Installment Sale | Seller financed deal distributes tax payments over time |
| Step Up Basis | Inherited property assumes market value at time of death |
| 2-3 Year Ownership Period | Many states exempt sales of inherited land during this timeframe |
| 1031 Exchange | Swap inherited land for another like-kind property to defer taxes |
Conclusion & Next Steps
Selling farmland and agricultural property for profit requires thoughtful evaluation of capital gains tax liability, as substantial taxes can erode net proceeds gained by your land sale or transfer. Rural landowners preparing for a transition should take time to explore special federal and state exemptions they may qualify for, as well as proactive strategies to minimize owed taxes so more wealth stays within their families.
In particular, inherited farmland merits careful handling to take full advantage of step-up basis, ownership period exemptions, and 1031 like-kind exchanges. Given the complexity of capital gains taxes related to selling or inheriting agricultural land, it is wise to consult early with specialized accountants, attorneys and financial advisors to map out a personalized plan matching your situation and goals.
Armed with the clear, comprehensive guidance within this guide, rural landowners and farmers can forge informed pathways toward selling, gifting or bequeathing their properties in ways allowing more proceeds to benefit their families and future generations.
Frequently Asked Questions
What are considered capital improvements to farmland that increase cost basis?
Capital improvements to agricultural land that can be added to the cost basis when determining capital gains taxes owed include any investments made that improve functionality or production capacity like:
Major upgrades:
- New irrigation & drainage systems
- Soil enhancement (liming, tilling, etc.)
- Constructing or expanding barns, sheds, facilities
- Clearing/improving farmland acreage
Infrastructure:
- New fencing
- Paving/gravel farm lanes and roads
- Installing livestock pens and handling facilities
Technology:
- Climate computer controls/monitoring in barns
- Sensor systems for monitoring crops
- Upgrading equipment to leverage precision farming technology
Be sure to keep careful written records of all capital improvements made over the years.
How does donating a conservation easement work to lower taxes on agricultural land?
Granting a conservation land easement permanently relinquishes future development rights on rural property to a designated land trust or agency. This lowers the assessed land value, which forms the basis for lowered capital gains taxes when eventually selling the agricultural land under easement restrictions. Additional tax deductions are also possible in the year the donation occurs.
The terms of easements vary – some restrict any future development while more flexible agreements may still allow limited farming structures. Land protected by conservation easements typically sells at 25-50% below market value for unrestricted land.
Consult with a qualified attorney to fully understand implications before granting an agricultural land easement.
What are Section 1031 like-kind exchanges for inheriting farmland?
Section 1031 exchanges allow heirs inheriting agricultural property to defer capital gains taxes by swapping that land for another like-kind property meeting specific IRS rules. Both relinquished and replacement properties must qualify as “like-kind” real estate intended for business or investment purposes.
Benefits of utilizing a 1031 exchange of inherited farms or rural land parcels include:
- Deferral of all capital gains taxes
- Acquisition of another income-producing agricultural property
- Preservation of wealth for heirs
Proceeds from the sale of inherited land not used to acquire the replacement property are subject to capital gains taxes. Consult a specialized tax attorney to ensure your 1031 exchange meets all IRS regulations.
How does acquiring farmland work using an installment sale contract?
Installment land contracts allow buyers to purchase agricultural property from sellers through a form of owner financing with scheduled mortgage payments over time, plus interest, until the full purchase price has been paid.
For income tax and capital gains purposes, each payment received by the seller under an installment sale contract gets allocated between interest income and reduction of the amount owed on the purchase price.
This allocation allows capital gains taxes to be spread out and paid incrementally over the duration of the installment land contract as the seller receives payments from the buyer. Structuring deals this way allows flexibility for buyers while deferring taxes for sellers.
Is there a difference in capital gains taxes for selling versus gifting farmland?
Yes, the tax implications differ significantly between selling agricultural land outright versus gifting it to heirs:
Selling
- Calculation of capital gains owed based on sale price less original purchase price and cost basis
- Payment of applicable federal and state capital gains taxes reductions net sale proceeds
Gifting
- No capital gains taxes applied since no sale occurs
- Gift tax only owed if over $12.92 million lifetime exemption
- Property gifted means heirs assume donor’s cost basis
Gifted land passing between generations is commonly called a “pass-through gift”, exempting taxes while passing the cost basis forward eventually subject to capital gains rules when heirs sell the land.
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