The Wall Street Journal had an article yesterday on how Chinese companies are continuing to invest in South America especially in buying up farm land to feed their people.  Through the twelve month period ended May 31, 2011, the China’s investment in Latin America had hit $15.6 billion.

During the last three years, more than 70% of their investments had been in energy and minerals, but farming is attracting more attention. 

This month, China’s largest farming company, Heilongjian Beidahuan Nongken Group signed a joint venture with Argentina’s Creud SA to buy land and farm soybeans.  Creud SA already controls more than 2.5 million acres of land in Argentina.  Heilongjian had already indicated back in March their intentions to purchase 500 thousand acres of land overseas during this year and Latin America is their primary target area.

They are also spending $1.5 billion to develop about 750 thousand acres of land in Rio Negro Province over a ten year period.  These developments will not be a direct purchase of land, but they will be in control of the production.

With the backing of the Chinese government, we will continue to see this type of investment going forward.

I noticed a post on the Iowa Farm Union that indicated 47% of the farm land in Iowa is owned by women.  I think this trend will continue and there may be a good chance that this percentage may be in excess of 50% at some point in the near future.  Women appear to express a desire for strong conservation in their stewardship of the land, but sometimes are not sure how to most effectively carry this out.  The Iowa Farm Union and other state organizations have several seminars devoted to this effort.

As a tenant farmer are you taking advantage of the differences between what is most important to men or women who own farm land.  What is most important to male land owners may not be most important to female land owners.  By knowing and understanding these differences, you can become a more effective farmer.

The new owner of the Whittemore Golf Course in Algona, Iowa has plowed it under to put in a corn crop for this year.  This nine hole course was originally built in 1969.  The new buyer decided that it would make more money as a farm than as a golf course.

This has caused some rift in the community since they now have lost their local course.  Here is an article on the change over.

I have a feeling that we might start to see more of this happen in smaller corn belt cities if corn and bean prices stay high and the golf participation continues to decrease.

With the rapid increase in farm land prices over the last year or so, many farmers are now considering selling some farm land to lock in these high prices.  The Tax Code allows a farmer to reinvest the proceeds from this sale into other real estate using a tax-deferred exchange under Section 1031 (commonly known as a 1031 exchange). 

Generally, the farmer has 45 days after the closing of the sale to identify the property they want to buy (usually 3 can be identified without any risk) and then another 135 days to actually purchase the property, or 180 days in total.

As we approach the beginning of July, farmers have another option using a 1031 exchange that is not available for sales before that date.  This option allows the farmer to receive cash from the sale (actually it must be held by a third party accommodator), but not report the gain until 2012 and pay the tax in 2013.

Here’s how it works. For any sale that happens after approximately July 5 has 180 days to identify and close on the purchase of the new property.  This 180 day period ends in January of 2012.If the farmer is unable to actually purchase replacement property during this time period, the installment sale rules determine when the gain is reported.  Under these rules, as long as the farmer had properly identified the replacement property and has been unable to purchase this property AND the cash is not received by the farmer until 2012, the gain is taxable in 2012 and the tax is due on April 15, 2013 (or March 1, 2013 under the applicable estimated tax rules).

This is a method to allow farmers to actually lock in the price, get the cash into an interest bearing account and defer the tax for an additional tax year.  This can be complicated and  involve a qualified accommodator to handle this type of transaction.  But deferring the tax on a $1 million-plus gain for another year may be worth the extra work involved.

We seem to be getting a lot of requests or searches on what the capital gains tax rate is for 2011.

In summary, capital gains and qualified dividend tax rates are as follows:

• Short-term (assets held less than a year) are treated as ordinary income.  This means that the maximum tax rate will be the same as your current top marginal tax bracket which can be as high as 35%.
• The depreciation recapture on equipment is also considered to be ordinary income.  This income is taxed in the year of sale even if no cash is received.  This can trip up farmers when they retire if they are not careful.  The top rate on depreciation recapture for the sale of real estate is 25%.
• For assets held for more than one year, the top capital gains tax rate is 15%.  If the farmer is in the 15% income tax bracket or lower, than the capital gains tax rate is zero.  This special rate only applies to the amount of the gain that is within this 15% tax bracket.  For example, if the 15% tax bracket ends at $70,000 and the farmer has other taxable income of $45,000 and a net long-term capital gain of $100,000, $25,000 would be taxed at zero and the remaining $75,000 taxed at 15%.
• Remember, that qualified dividends from a C corporation are also subject to this special lower tax rate.  If you have retained earnings in a C corp, this year and next would be a great time to considered distributing those earnings and not paying more than 15% tax on the dividend.

These are all federal tax rates.  Most states tax capital gains and dividends as regular income, however, certain states may have reduced rates for capital gains.  Please make sure to check with your tax advisor for your local state tax rules.

There has been a lot of talk lately in the press about whether farm land prices are entering a bubble phase similar to farm land in the early 1980′s or tech stocks in the late 1990′s.

I decided to take a look at farm land prices for good Iowa farmland from 1950 to 2010 and see how long it took for prices to recover back to the old peak.

Good farmland in Grundy County, Iowa peaked out in 1981 at approximately $2,947 per acre.  It bottomed in 1986 at $1,047 or a drop of about $1,900 or 65%.  It took from 1986 until 2003 or 17 years for the average price of farm land in Grundy County to top $3,000.  From start to finish, it took about 22 years for the cycle to finish.  Now, what is not factored into this is that farm land continued to return cash rent each year.  This probably averaged a 3% or so return each year.

Most crashes from any bubble usually correct from about 50-65% each time.  Therefore, if prices are around $10,000 right now and this is the top, farm land may not fully stop sliding until it hits $3,500 – $5,000 in value.

I am not suggesting that we are in a bubble right now, however, all prices of stock, bonds, commodities and farm land do tend to go in cycles, so if we are in a bubble, it may take several years for prices to fully recover.

We got a follow up question from our reader last week regarding Section 1031 tax-deferred exchanges:

“This is a follow up question to your answer about “Defer Gains” on March 16th Who normally is an “accommodator” and can that monies held by the accommodator be rolled to pay off our existing mortgage on our home. Does it have to be applied to a new purchase of property. ?? Thank You..”

The accommodator is like an escrow agent in that they will handle the proceeds from the sale of the property and hold them until new property is identified and acquired.  There has been some losses in this area with certain accommodators using the funds to invest in risky investments and you should make sure to investigate the accommodator and make sure that they use a segregated escrow account that does not co-mingle your funds with other funds.

With regards to the question on can the monies be used to pay off existing mortgages, etc.  The direct answer is no.  I will get get several calls a year regarding the sale of property and then rolling that sale into a new piece of property.  In almost every case, the taxpayer will tell me how much cash they are receiving and they think they only have to roll over the cash.  The correct answer is that they have to roll over the net sales price including all of the cash received.  Here is an example:

Sales Price $500,000 less mortgage of $250,000 equals net cash of $250,000.  The taxpayer has to roll over the full $500,000 including all of the cash of $250,000. 

Another common misunderstanding is that if you roll over less than the sales price, then the gain will still be deferred on a pro-rata basis.  For example, if you sell the property for $500,000 and your basis is $250,000, most taxpayers assume that if they do not rollover $50,000, then 50% will be non-taxable and 50% will taxable.  The correct answer is that 100% will be taxable.  Also, if you roll over less than 100% of your basis (in this case $250,000), all of the gain will be taxable.

To make a proper use of tax-deferred exchange requires the use of an accommodator and it should always be in conjunction with your tax advisor.

We had a reader ask us the following question:

“When we sell our farm (that is currently cash rented out) is there any capital gains break if that “gain” is invested with a certain certain period of time.”

When the real estate market was hot several years ago, many real estate investors took advantage of a tax-deferred exchange to defer their income tax on the sale of real estate.  Many of these investors rolled their gain over into farm land.

Now that the farm land market is heating up, many farmers may want to lock in their gain and sell their property.

They have two options:

1. Pay the income tax at a federal rate of 15% (can be higher for recapture of depreciation on personal property and buildings),
2. Defer the gain by rolling the sale of the property into other real estate.

Some sellers are able to do an immediate exchange of property with other taxpayers, however, the substantial majority of sellers take advantage of a tax-deferred exchange by using an accommodator to handle this transaction.  An accommodator will hold the funds while the seller finds other property to purchase and then transfer the funds to handle this purchase.

The key dates on this type of exchange is from the date you actually sell the property, you have 45 days to identify the property you want to buy and a total of 180 days to actually purchase the property.

I have many taxpayers call me after selling the property to ask about deferring the gain.  I will ask if they used an accommodator and they indicate they have already gotten the cash from the sale.  I then have to tell them that they are too late since any time you receive the cash personally, you can no longer defer the gain.

Remember, you must engage the accommodator before selling the property.

Also, you do not have to reinvest the proceeds in other farm land.  You can roll over the gain into almost any type of real estate such as apartment buildings, retail, office, etc.  If your land has substantial personal property such as irrigation equipment, etc. this gain can not be rolled into real property and may be taxable.

The Federal Reserve of Kansas City on Tuesday reported that farm land values in their district had risen substantially from the previous year.  The year-over-year rise for non-irrigated land were as follows:

• Kansas            19.5%
• Missouri          6.6%
• Nebraska       17.6%
• Oklahoma        5.0%

The overall value for their district was a 14.8 percent rise for non-irrigated crop land and 12.9 percent for irrigated.  Rising farm income, especially for crop farmers, drove the prices up almost 20% in Kansas and Nebraska.

Although farmland prices are up sharply, cash rents increased an average of 6% for crop land and 4% for ranch land.

Farm real estate loan-to-value ratios ranged from 50% to 90% with an average of 70%.  Many bankers are now putting a cap on a set dollar per acre that they will loan on.  For example, if the appraised value is $7,500 per acre, the bank may only allow an use of $5,000 per acre to loan against.  This will normally require more of a cash investment by the farmer.

The farm income index soared in the fourth quarter approaching the highs set in 2008.  I saw another article where the USDA is perdicting net farm income for 2011 of about $98 billion .  It would not surprise me that we will go over $100 billion with the continued strong farm commodity prices across the board.

We got the following question from a reader:

“If I 1031 a bare land parcel for a parcel with improvements can I depreciate the improvements?”

Before, I answer the question, lets review what “1031″ means.  1031 refers to the section of the Internal Revenue Code dealing with tax-deferred exchanges.  Under a 1031, a farmer can defer the gain on the sale of land by reinvesting the total proceeds into other like-kind real estate.  Some misconceptions about this is that a lot of taxpayers do not understand that raw farmland is like-kind with other real estate such as apartment buildings, retail strip centers, etc.

Another tricky part of a 1031 exchange is that normally the farmer needs to use a facilitator to handle the exchange during the whole process.  I get many calls through-out the year from my clients saying that they sold a piece of property (without calling me first), got the cash and now want to know how to finish up the exchange so they can defer the gain.  They are too late. 

In order to have a proper 1031 exchange, the farmer must:

1. Enter into an exchange agreement with the facilitator,
2. Have the closing proceeds transferred at closing to the facilitator,
3. Identify the property they want to acquire within 45 days, and
4. Purchase that property within another 135 days or 180 days total.

There are no extensions on either the 45 day or 180 rule and if you miss any of these steps, you no longer have a qualified exchange.  These rules are complex and you need to review them with your advisor.

For the current question, the rollover of the land into the land with improvements will allow the farmer to allocate their basis partly to the land, which can not be depreciated, and partly to the improvements which can be depreciated.  Normally, this allocation is based upon the fair market value of the improvements over the total sales price times the basis in the property.