Ask the Taxman-Like-Kind Exchanges, Housing Deduction, LLC Value02/13/2017
Our parents left their land to my brother, sister and me. We have a crop-share arrangement with a young farmer and are working to divide the properties. Since we continued operating the farms together, how long do we have to wait to make a like-kind exchange of properties to divide the land among the three of us?
Apparently you have learned that there is a requirement that property must be held in a business or rental status in order to conduct a Section 1031 like-kind exchange. However, the law is not specific with respect to any required holding period to establish that business or rental status.
Most tax advisers like to see their clients hold real estate in business or investment use for at least two years before conducting a Sec. 1031 like-kind exchange. There are other areas in the tax law that use a 24-month period as indicative of the status of an asset. In summary, if it has been at least two crop years since the estate transferred the land to the three of you equally, you should now each be able to exchange your undivided one-third interest in some parcels for specific title to other parcels, resulting in each of you directly owning land that is all yours. Due to related party rules, none of you can sell your respective properties in a taxable transaction for at least two years after the exchange. Otherwise, all of the exchanges will be taxable, back to the date of the original exchange.
But exercising caution around the like-kind exchange rules is only important if there is a significant gain associated with the land. For example, if the most recent parent’s estate was a year ago, and all of the land was includible in that deceased parent’s estate so that the land received a fresh tax basis equal to its fair market value, there may be little or no gain to be concerned about. The question of whether the land was fully includible in an estate is a technical issue. For example, if Mom’s death was the most recent and her interest in the land was a life estate set up by Dad, that land did not get a basis increase at her death — only a step-up at Dad’s earlier death. See the tax professional or attorney who assisted with the most recent estate, as you should identify the tax basis in the land even if all exchanges are conducted as tax-deferred under Sec. 1031.
I own an 80-cow dairy with one full-time employee. I recently purchased a trailer home at the nearby trailer park for him to live in. I pay the monthly lot rent, insurance, property taxes, and cover any repairs on this home; he is responsible for utilities. We agreed to lower his hourly wage to offset the housing arrangement. Can I use the trailer home purchase for the Sec. 179 deduction? And can I deduct the housing costs I pay for him as labor? Is this taxable or tax-free on his W-2?
I would have a great answer for you but for one phrase in your fact pattern: A trailer home at the nearby trailer park. An employer may provide tax-free housing to an employee for the business needs of the employer, but a condition is that the housing must be on the employer’s business premises. Thus, if the trailer home was at your farm site to allow this employee to be available to assist at all hours with dairy herd emergencies, it would be a tax-free fringe under Sec. 119. However, under the facts you described with housing away from your farm, the amounts paid for his housing costs must be treated as compensation and added to his Form W-2. But one bit of good news: This is a non-cash wage provided for agricultural labor, so federal payroll taxes (FICA, Medicare and unemployment) are not applicable. Regarding the purchase of the trailer home, the Sec. 179 deduction is specifically not available for any property used to furnish lodging, regardless of where located.
We have an LLC that holds our farmland and one of our stock brokerage accounts. We formed this to protect the land from potentially bad decisions by our two children during their formative years. The LLC by-laws allow only for lineal descendants to have ownership, and it requires 100% agreement to sell the land. Presently, my wife and I are the only owners; the LLC will pass to our children and four grandchildren. Do we get a step-up to market value at the time of our death? It looks like this value would be less than the current estate exemption. So if the new group of LLC stockholders (our children or grandchildren) decided to sell, is the cost basis the step-up value? This is important to us as the land has been in my wife’s family for decades and has a very low tax cost.
Technically, the asset in the estate of you and your wife will be the LLC ownership units, not the underlying land or the stock account within the LLC. However, the value of the LLC interest will generally be reflective of the inside assets. Assuming your LLC continues to be a partnership for tax purposes, there is an election that can be made under Sec. 754 after death to apply the step-up in basis in the LLC ownership units to the assets inside the partnership. This will accomplish your objective of obtaining a step-up in basis of the land.
The other issue to consider is the two children’s expectations when they eventually inherit the LLC ownership. Are you passing it directly to the two children, or are your wills also directing some ownership to the four grandchildren? As time goes on, dropping down another generation could be problematical, as it gets increasingly difficult to reach management decisions with more owners (recognize that there likely will be spouses with those grandkids, if not already, and the number of financially interested parties is doubled). If all four grandchildren must agree before a sale or division of land occurs, there is the possibility of disagreement that causes a rift within the family. I would suggest a serious discussion with your two children about your mutual expectations when they become owners of this land. As long as the LLC stays in partnership status, it is relatively easy to unravel by distributing specific land to each owner. But that can more readily be accomplished when there are two children as owners; it is much more difficult with four grandchildren as owners. The plan of holding the land together in order to provide rental income can make good sense. But what’s the end game? Without an exit plan, you increase the likelihood of a family blow-up a generation or two down the road.
Editor’s Note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years’ experience in ag taxation, including as a trainer for the American Institute of CPAs and other technical seminars. To pose questions for future tax columns, e-mail AskAndy@dtn.com.