How 453 Trusts Help Farmers and Agricultural Landowners

Farmers and agricultural landowners who own valuable real estate may wish to sell that property when they retire or otherwise leave the agricultural industry. However, if that property has gained value, the profits from that sale can trigger significant capital gains taxes. One way to mitigate the cost of these taxes is through a 453 trust, or deferred sales trust (DST).

At 453 Trust Powered by Pennington Law, our national practice of seasoned professionals helps landowners with matters such as trusts and estates, tax planning, asset protection, and financial advisory services. Unlike other firms that outsource certain aspects of their clients’ cases to other professionals, we are a comprehensive team that addresses these matters under one roof. If you want to learn more about avoiding capital gains tax on farm sales, contact us now for an initial case review with a knowledgeable 453 trust attorney. 

The Challenges of Capital Gains Taxes for Agricultural Property Owners

Agricultural property can increase significantly in value over time, especially as farmland demonstrates its productivity. As a result, landowners may face a substantial capital gains tax bill when they sell their property. Federal long-term capital gains rates range from zero to 20 percent depending on income, and high-income taxpayers may also be subject to the 3.8 percent Net Investment Income Tax (NIIT). State taxes, depreciation recapture, and adjustments to the property’s basis can also affect the total tax owed, so landowners should review their situation with a qualified professional.

Why Farmers and Agricultural Landowners Consider 453 Trusts

Farmers and agricultural landowners who worry about the financial and tax burden of selling farmland should consider using a 453 trust because it offers:

• Deferral of capital gains tax: A deferred sales trust allows a landowner to avoid an immediate capital gains tax bill in the year of selling their property. Instead, DSTs allow landowners to pay capital gains taxes over time as they receive payments from the trust based on the sale proceeds.
• Asset protection: Some 453 trusts are structured as Nevada Domestic Asset Protection Trusts (DAPT), which can provide strong protection from most creditor claims. Not all deferred sales trusts automatically use Nevada law, so asset protection depends on how the trust is established.
• Estate planning: A 453 trust can be integrated into an agricultural landowner’s estate plan to help preserve wealth for future generations. Depending on whether the trust is structured as a grantor or non-grantor trust and applicable state law, the unpaid balance of the note may be included in the landowner’s estate, while properly structured trust assets generally remain protected. 

How a 453 Trust Works for Farmland Sales

A 453 trust leverages Internal Revenue Code Section 453 to manage the tax implications of selling highly appreciated assets like farmland. Under this arrangement, a farmland owner can defer capital gains taxes by structuring the sale as an installment sale through the trust, spreading the tax liability over multiple years as they receive payments from the trust.

While some landowners choose to structure a 453 trust as a Nevada Domestic Asset Protection Trust (DAPT) for additional creditor protection, the trust can also be established under other jurisdictions, depending on the landowner’s goals. Importantly, the landowner cannot retain control over the trust or its assets so that the IRS recognizes the arrangement as a legitimate installment sale rather than an attempt to avoid taxes.

The process of selling farmland through a 453 trust generally involves the following steps:

• The landowner establishes an irrevocable trust structured to qualify for IRC §453 installment sale treatment.
• The landowner sells the farmland to the trust in exchange for a promissory note specifying installment payments.
• The trust then sells the property to an unrelated, bona fide third-party buyer.
• The landowner reports the sale to the IRS and pays capital gains tax on the gain portion of each installment as payments are received under the installment sale contract.

Legal and Compliance Considerations for Agricultural Landowners

A 453 trust must follow these rules to be legal and effective:

• There must be an independent fiduciary: The IRS generally requires an independent party to serve as trustee or fiduciary to maintain the tax-deferral benefits and avoid self-dealing issues. This ensures the seller doesn’t retain direct control over the proceeds.
• There can be no prearranged sales: A landowner must not pre-plan the sale of their property before creating the 453 trust.
• There can be no monetization of sale proceeds: A landowner who sells their property through a 453 trust may not monetize the sale proceeds by taking out a loan against or otherwise pledging their right to payments from the trust. Otherwise, the IRS could challenge the trust as one designed primarily to avoid taxes.
• The property owner cannot control the trust: A property owner may not control a 453 trust or its investments.

To maintain favorable tax treatment from the IRS, proper structuring is crucial when creating a 453 trust. Seek guidance from an experienced attorney to help set up a legally compliant trust using the installment method.

453 Trusts vs. 1031 Exchange for Agricultural Land

Agricultural landowners may have options beyond 453 trusts for managing capital gains taxes when selling their property, such as 1031 exchanges. While these two instruments have similar goals, they also differ in:

• Capital gains treatment: A 453 trust defers capital gains tax liability over time, as an agricultural landowner pays capital gains tax only on the sale proceeds when they receive payments from the trust under its installment contract. Conversely, a 1031 exchange defers capital gains tax when a landowner uses the sale proceeds to purchase a “like-kind” replacement property.
• How they dispose of sale proceeds: In a 453 trust, the trust receives the sale proceeds and invests them in qualified assets, which generate payments to the landowner over time. In a 1031 exchange, the sale proceeds must be used to purchase like-kind replacement property within IRS deadlines.
• Which parties are necessary: A 453 trust requires an independent trustee to manage the trust. Conversely, a 1031 exchange requires a qualified intermediary to handle the sale proceeds.

Section 1031 exchanges have strict requirements that landowners must follow to obtain the tax benefits of the exchange, including:

• Sale proceeds must be reinvested in replacement property of equal or greater value.
• Replacement property must be identified within 45 days and purchased within 180 days of selling the original property.

Get a Free 453 Trust Assessment for Agricultural Landowners or Farmers

Are you thinking of selling high-value agricultural land that has gained in value, but worry about the capital gains tax consequences? Talk to the experienced attorneys at 453 Trust Powered by Pennington Law. We can discuss how you may be able to defer taxes and potentially grow your wealth through a 453 trust. Contact us today for a free consultation.