Inherited Land or Farmland: Should We 1031 Exchange or Just Pay the Tax?

Start from the estate's number: your gain is only what the land has grown since the date of death

§1014(a)(1) sets an heir's basis at fair market value on the date of death, so the parents' 1960s purchase price and decades of appreciation are gone from the calculation. A developer paying $10,000,000 for land the estate valued at $8,000,000 creates a $2,000,000 gain, not a $9,800,000 one, and §1223(9) treats it as long-term however soon the sale closes.

If the estate filed Form 706, §1014(f) caps your basis at the value reported on Schedule A of Form 8971; if the estate was under the $15,000,000 filing threshold, a dated appraisal is the record to keep. An executor may also have elected the six-month alternate valuation date under §2032, which changes the starting number.

At 2026 rates the $2,000,000 gain is taxed at 20% above $613,700 of joint taxable income plus 3.8% net investment income tax under §1411, about $476,000 in federal tax before any state tax.

If the estate elected special-use valuation, your basis is lower and a sale within ten years triggers recapture, but an exchange does not

§2032A lets a farm estate value qualified real property at its farm-use value rather than its development value, reducing the gross estate by up to $1,460,000 for 2026 deaths under Rev. Proc. 2025-32. The trade-off lands on the heirs: §1014(a)(3) makes that lower special-use value the income-tax basis, and §2032A(c) imposes an additional estate tax if, within ten years of death, a qualified heir disposes of the land to anyone outside the family or stops the qualified use.

§2032A(i) carves out the exchange: swapping the qualified real property 'solely for an interest in qualified exchange property in a transaction which qualifies under section 1031' triggers no recapture, and a partial exchange reduces the recapture in proportion. For a family inside the ten-year window with a developer's offer, an exchange into other qualifying farmland is the route that avoids both the income tax and the additional estate tax; ask the executor whether the election was made before you sign anything.

Allocate the price among land, buildings, equipment, crops and the house before you sign, because each is taxed differently

Reg. §1.1031(a)-3 defines real property as 'land and improvements to land, unsevered natural products of land, and water and air space superjacent to land,' so the acres, the barns and other inherently permanent structures, and the standing crop can all go through the exchange. Tractors, vehicles and equipment that is not permanently affixed are personal property: their price is a separate sale, taxed as ordinary income under §1245 to the extent of depreciation taken since the date of death.

An unharvested crop sold with land held more than a year to the same buyer is §1231 property under §1231(b)(4), and a farmhouse an heir has lived in for two of the last five years can qualify for the $250,000 or $500,000 exclusion under §121, which Pub. 225 notes requires allocating part of the price and basis to the home. Where the sale transfers a going farm business, both sides report the allocation on Form 8594 using the residual method, with land, buildings and equipment in Class V.

• Hypothetical $10,000,000 allocation: $9,200,000 land, $400,000 barns and bins, $250,000 equipment, $150,000 farmhouse.
• Exchangeable through the intermediary: $9,600,000 of land and permanent improvements.
• Outside the exchange: $250,000 of equipment (ordinary income to the extent of post-death depreciation) and the farmhouse (§121 if occupied, otherwise taxable gain since death).

Four places land heirs can exchange into: more farmland, income property, DSTs, or net-leased land

Any real property held for investment is like-kind to any other under §1031(a)(1), so farmland can become an apartment building, an industrial warehouse or a fractional DST interest; the eligibility rules cover the holding and use tests. Farmland to farmland keeps the family in agriculture and cash rent; an industrial or multifamily property adds tenants and management; a DST takes the management away and can be split among heirs in whatever dollar amounts each wants.

A ground lease is the closest passive analogue to farmland: you own the dirt, a tenant owns and operates the building, and the net-lease income arrives without repairs. For parents still living who want income now and a simple estate later, a DST or ground-lease replacement produces both, and the step-up at their death clears the deferred gain a second time.

When paying 23.8% and investing $9,500,000 freely beats staying in real estate

Pay the tax when the gain since death is small, when heirs want diversified, liquid assets rather than another property, or when nobody in the family wants to identify replacement property inside 45 days. In the hypothetical, $476,000 of tax buys the freedom to put $9,500,000 anywhere, with no deadlines, no sponsor risk and no illiquidity; if the land's basis nearly equals the offer, the tax is a rounding error and the exchange's costs and constraints dominate.

Exchange when the gain is large, when a §2032A recapture window is open, or when the family wants the money to keep producing rent for an aging parent whose death will step the basis up again. A family can also split the difference: exchange the acres with the most gain and sell a parcel with little, using the risk checklist to keep the exchange itself clean.

Coordinating several heirs: split the title, let each heir choose, and consider an exchange for a living parent before the sale

Distribute the land to the heirs as tenants in common before the sale, so each undivided interest can be sold for cash or exchanged separately; a sibling who wants cash takes it, and a sibling who wants income exchanges into DSTs. Holding the land in a family LLC or partnership blocks that choice because §1031(a)(2) excludes partnership interests from like-kind treatment.

If a parent still owns the land, the parent can exchange into passive income property now and leave DST interests that step up under §1014 at death, sparing the children a shared farm to argue over; the legacy question of keeping the homestead parcel can be settled by carving it out of the sale. Confirm the allocation, the §2032A status and each heir's exchange with your CPA or attorney before the contract is signed.