1031 Exchange for an Orchard or Vineyard

The trees, vines and land go through the exchange; the crop in the bin and the equipment stay out

Treas. Reg. section 1.1031(a)-3 defines real property to include unsevered natural products of land, naming growing crops and plants, and its Example 1 is a field of perennial fruit-bearing plants: the plants are real property, and the fruit stops being real property the moment it is picked. Storing harvested fruit on or in the property does not change that.

So an orchard or vineyard sale divides into a real-property part and a personal-property part. Land, bearing trees and vines, wells, barns and packing sheds that are permanently affixed, paved areas and fences belong in the exchange; the regulation lists fences, paving and grain bins and silos among inherently permanent structures. Tractors, sprayers, harvest bins, frost fans that can be moved, and any fruit or wine inventory are personal property, and the money paid for them should not pass through the intermediary.

Trellis wire, drip lines and in-ground irrigation are not on the regulation's lists, so they are judged on the regulation's permanence factors or on your state's property law. Water rights that run with the land follow the separate rules on our water rights and easements page, which matter for most irrigated plantings.

Depreciated trees and vines can make part of an exchange into a building taxable as ordinary income

IRS Publication 225 depreciates trees and vines bearing fruits or nuts over 10 years straight line under GDS, or 20 years under ADS, starting when they produce a crop worth harvesting commercially; section 168(e)(3)(D) puts them in the 10-year class. If you elected out of the uniform capitalization rules, section 263A(e) treats the plants as section 1245 property and adds the preproductive costs you deducted to the recapture amount; Publication 225's apple-orchard example shows that amount reported on Form 4797 as ordinary income.

The real-property definition does not change recapture. Paragraph (a)(7) of the same regulation says a taxpayer transferring section 1245 property in a section 1031 exchange stays subject to the section 1245 gain rules, even though the property is real property for exchange purposes. Under section 1245(b)(4) and Reg. section 1.1245-4(d), recapture in an exchange is capped at the gain recognized plus the fair market value of non-1245 like-kind property you receive. The Form 8824 instructions carry the same test on line 21 under the heading section 1245 real property.

Hypothetical: a vineyard with $400,000 of depreciation taken on the vines, and an adjusted basis well below the sale price, is exchanged entirely for an apartment building and land worth $3,000,000. No cash comes out, but the non-1245 property received exceeds $400,000, so the full $400,000 can be ordinary income. Exchanging into another planted orchard, or a replacement whose cost includes enough section 1245 components, can reduce it. Whether your plantings are section 1245 property if you never elected out of the capitalization rules is a classification question to settle with your CPA before you choose a replacement; run your own numbers with your CPA.

Sell with the crop on the tree, or harvest first and sell the crop separately

If you sell the land with an unharvested crop at the same time and to the same buyer, and you held the land more than a year, section 1231(b)(4) treats the crop as property used in the business. Section 268 then denies a deduction for the cost of raising that crop, and Publication 225 tells you to add those costs to the land's basis instead. Because a growing crop is real property under the exchange regulation, its share of the price can go to the intermediary with the land.

If you harvest before closing, the fruit is inventory, its sale is ordinary farm income on Schedule F, and that money stays outside the exchange. The farmland page covers the general crop and livestock split for row-crop farms; the orchard-specific point is that a perennial crop takes years to come back, so buyers price the planting's age and variety as much as the year's fruit.

Replacement options when you are ready to stop farming permanent crops

Any U.S. real property held for business or investment is like-kind to an orchard. Reg. section 1.1031(a)-1 gives city real estate for a ranch or farm as an example of a like-kind trade, so an aging grower can move into rental property, net-leased buildings or a traditional DST without changing the tax result.

The replacement choice now has a recapture dimension. If your plantings carry large section 1245 recapture, compare a replacement mix that includes another planted farm, or depreciable components that qualify as section 1245 property, with a building-only replacement that may release the recapture as ordinary income. A bonus depreciation fund can sometimes create deductions against the ordinary income that remains, subject to the passive-activity rules your CPA applies.

• Another orchard or vineyard: keeps the plantings' recapture deferred, keeps crop, frost and water risk.
• Cash-rented farmland: lower management, but land alone is non-1245 property for the recapture cap.
• DSTs or net-leased buildings: no farming at all; check the section 1245 effect before you identify.

Buying an orchard or vineyard as replacement property: plantings, water and the grower before day 45

Buyers coming from other real estate should underwrite the plantings first. Ask for planting dates, variety and rootstock records, block-by-block yields, and the replant schedule, because a block near the end of its productive life is a capital bill, not income. Trees acquired before they reach the income-producing stage are not depreciated until they bear a commercial crop, and Publication 225 requires preproductive costs on plants with a preproductive period over two years to be capitalized unless an exception or election applies.

Water decides value. Confirm the source, the legal right, well records and any district allocation, and have the water rights transfer reviewed under state law before you identify. If a grower will lease the property, get a written lease and the grower's operating history, since that rent is what the exchange buys.

Price the deal in two contracts if it includes equipment or crop inventory, so that only the real property is paid with exchange funds. Reg. section 1.1031(k)-1 lets you identify three properties of any value, or more if their total stays within 200% of what you sold, and personal property worth up to 15% of the real property can ride along as incidental property for identification without making it like-kind. Order soil, water and title reports the day your own sale goes under contract, because an orchard's diligence rarely fits in 45 days otherwise.