How are farm equipment, livestock and crops handled in a 1031 sale of the farm?

Since 2018 only real property can be exchanged, and the regulations draw the farm line clearly

Section 1031(a)(1) now covers only real property. Reg. section 1.1031(a)-3 defines it as land, improvements to land, and unsevered natural products of land, and lists barns, fences, grain storage bins and silos as inherently permanent structures.

Growing crops are expressly included: unsevered natural products of land, including growing crops and plants, are real property, and they stop being real property once severed. The regulation's example of a fruit orchard says the trees are real property but the harvested fruit is not, even if stored on the property.

Tractors, combines, trucks, irrigation pivots that are not permanently affixed, and every animal are personal property. Publication 225 says personal property such as tractors and equipment no longer qualifies for a like-kind exchange.

Each asset is taxed by its own class, so the allocation drives the bill

Publication 225 says a lump-sum sale of a farm is treated as a sale of each individual asset, and if the assets make up a trade or business the residual method must be used. Buyer and seller may have to report the allocation on Form 8594.

Equipment gain is ordinary income up to the depreciation you took, under section 1245; only gain above original cost is section 1231 gain. When machinery sells for less than it originally cost, all of its gain is ordinary.

Livestock held for draft, breeding, dairy or sporting purposes is section 1231 property under section 1231(b)(3) if cattle and horses were held 24 months or more and other livestock 12 months or more. Animals held primarily for sale are ordinary income on Schedule F, and Publication 225 says raised animals have zero basis if you deducted the cost of raising them.

Crops in the field travel with the land, and their costs move into basis

Section 1231(b)(4) treats an unharvested crop on land held more than one year as property used in the business when the crop and the land are sold at the same time to the same person. Publication 225 adds that you cannot deduct the cost of raising an unharvested crop sold with the land; those costs are added to the land's basis.

So a field of wheat sold with the farm becomes part of the real property in the exchange. Grain already harvested and sitting in the bin is a farm product, and its sale is ordinary farm income.

Timing therefore matters. Closing before harvest pulls the crop's value into the deferred side; closing after harvest leaves it on Schedule F. Standing timber follows the same rule; see exchanging timberland.

Worked example: a $3 million farm sale with $440,000 outside the exchange

Hypothetical, round numbers; run your own numbers with your CPA. You sell your farm for $3,000,000: $2,500,000 for land and buildings, $60,000 for wheat still in the field, $350,000 for machinery and $90,000 for a raised breeding herd held more than 24 months.

The land, buildings and growing wheat, $2,560,000, go to the qualified intermediary and can be exchanged. The machinery cost $450,000 and has been depreciated to a $50,000 basis, so $300,000 is ordinary income under section 1245.

The herd's raising costs were deducted, so its basis is zero and the full $90,000 is section 1231 gain. About $390,000 of gain is taxable no matter how well the exchange goes.

• Exchanged: $2,560,000 of real property, including the growing crop.
• Taxable: $300,000 ordinary equipment recapture and $90,000 of livestock gain.
• Proceeds from equipment and livestock can go to you directly at closing.

What to do before the contract is signed

Get a written allocation in the purchase agreement, supported by an equipment appraisal and a herd valuation. Route only the real property proceeds to the intermediary; equipment and livestock cash paid at closing is taxed either way, and mixing it in adds nothing.

If you are buying replacement farmland with equipment included, the personal property you receive is boot to you. The regulations let the intermediary handle personal property incidental to the replacement real property up to 15% of its value without breaking the exchange safe harbors, but the personal property is still taxable boot; see what boot is.

Farm families leaving operations often exchange the land into passive real estate. A Delaware statutory trust interest is treated by Rev. Rul. 2004-86 as acquirable in an exchange, and farmland into apartments and the farmland property page cover the replacement side.